SVB Asset Management Economic Report Q1 2014
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Transcript of SVB Asset Management Economic Report Q1 2014
Table of Contents
Thoughts from our CIO 03
Overview 04
Domestic Economy 07
Federal Reserve 17
Special Topic: U.S. Banks 20
Markets & Performance 24
Global Economy 34
Portfolio Management Strategy 40
2 SVB Asset Management | Quarterly Economic Report Q1 2014
January and February presented a continuing challenge for economic forecasters. Was the U.S. economy slowing or was inclement weather simply pushing activity from one month to the next? Even now, it's difficult to say with confidence which is correct, but across all sectors we are seeing signs of growth. Consistent with the prevailing mantra, the growth we are seeing is not as strong as we would like, but there is growth nonetheless.
Overall, GDP in the first quarter will slow to around 1.5–2 percent. However, the growth components of consumer activity, lower fiscal restraint, and gains in employment and housing are poised to continue into future quarters. Consumer spending slowed in the quarter from a blistering 3.3 percent pace in the final quarter of 2013, the fastest in three years. Recent income growth will likely support further activity in this sector.
Internal measures of the job market have turned positive. We are seeing higher full-time employment, better attitudes and increased turnover associated with a healthy labor market.
Housing activity and prices remain well below the peak, but the trend is moving favorably. Though higher mortgage rates provided an initial shock, continued improvement in the labor market should overcome a further 1-2 percent increase in rates from here.
Janet Yellen's first FOMC meeting caused some headlines when she implied the first rate increases could happen as early as next summer. However, the Fed also made clear, it plans to keep rates lower than normal even after the economy achieves its goal of balanced employment and inflation.
Our special topic in this quarter’s report looks at how the banking industry is managing its balance sheet in order to prepare for higher interest rates by shifting assets from "available for sale" to "hold to maturity”. This effort will assist in stabilizing reported earnings even as long-term investments are marked down by higher yields.
The bond markets came back into favor this quarter as emerging market fears reignited the old "risk off" trade. Flows into bond funds and performance by bonds in general led the way, once again solidifying the value of diversification despite today's low rate environment.
Europe moved into the growth column even as deflationary fears increased. In contrast, the outlook for a slower China is damaging many emerging markets that have relied on China as an importer of raw materials and goods.
The Russia-Ukrainian issue seems to be fading, but only because the West is reluctant to react significantly. Uncertainty around Putin's next move must be built into the market outlook, although many seem to believe this potential crisis has passed
Looking ahead, expect continued stability in the markets as the Fed reigns in QE, the ECB considers initiating QE and Japan is left analyzing the effects of higher taxes meant to pay for past QE. We won't believe we are fully past the storm until we can leave such artificial stimulus behind.
Joe Morgan, Chief Investment Officer 3
Thoughts from our CIO
Shrugging Off the Weather
SVB Asset Management | Quarterly Economic Report Q1 2014
4
The U.S. economy continues to expand thanks to the consumer and less fiscal drag. (p. 7)
The consumer has benefited from rising home prices and equity markets. The first quarter could see a pull back on personal consumption due to extraordinarily cold weather in the Northeast. (p. 8)
The rise in household net worth boosted spending and overall sentiment. Household worth continues to hit all-time highs. (p. 9)
Most measures of the housing and employment markets confirm improving trends; however, the pace of improvement is slower than we prefer. (p. 10-13)
Inflation continues to run well below the Fed’s target measure of 2 percent. (p. 14)
Domestic Economy The Fed continues to taper at a pace of $10 billion per month. Fed Chair, Janet Yellen, has stated that tapering is not on a set course, although at this rate tapering will be complete by fall of 2014. (p.16)
In the March FOMC meeting there was a change to forward guidance, removing the 6.5 percent unemployment target and shifting to more qualitative measurements. (p. 16)
In addition, in the March FOMC meeting, Yellen said that rates could be increased as soon as six months after tapering ends. (p. 16)
Markets reacted to the March FOMC meeting by selling off and increasing volatility. (p. 16)
The Fed
Overview
SVB Asset Management | Quarterly Economic Report Q1 2014
Overview
5
Money market fund assets are hitting a dip, while bond funds show signs of renewed interest. (p. 24)
Bond investors continue to look to the short end as a safe haven to hedge near to intermediate term interest rate risk. Therefore, short end yields for agencies, corporates and structured products will continue to be anchored on the low end. (p. 25)
Credit finished the first quarter on a very strong note due to tighter spreads and a relatively stable interest rate environment. (p. 26)
Income returns from credit continues to provide the majority of the overall returns. (p. 27)
Inclement weather and domestic production are affecting energy commodities and metal investors continue to monitor the conditions in China. (p. 29)
Markets/Performance Global Economy
Banks typically make up a significant portion of short-term investment portfolios. (p. 20)
With interest rates rising, what will be the impact on the U.S. banks’ balance sheet? (p. 20)
U.S. banks’ balance sheets have strengthened since the financial crisis, but an upward movement in interest rates may translate to unrealized losses. (p. 21)
One of the steps taken by banks is to recognize that these are unrealized losses and shift the securities to hold-to-maturity (HTM) bucket to minimize accounting losses. (p. 22)
Liquidity can still be obtained for these HTM securities via the large repo market. (p. 22)
Special Topic: U.S. Banks
Europe: Differing growth levels pose upside risk to GBP and downside risk for EUR. (p. 34)
China: The Yuan is deflating on doubts about meeting growth target. (p. 36)
Japan: The BOJ may expand QQE policy to support inflation and growth targets; Yen is slower on improving. (p. 37)
U.S.: Dollar risks upside amid tame inflation, macroeconomic strength, and trimmed QE program. (p. 38)
SVB Asset Management | Quarterly Economic Report Q1 2014
Domestic Economy
-4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0%
10.0%
GDP on the Right Track GDP
Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Note: GDP values shown in legend are % change vs. prior quarter annualized.
GDP and Components GDP Growth 4Q Average – Long View
The final Q4 2013 GDP reading was revised higher to an annualized 2.6 percent from 2.4 percent.
The upward revision was propelled by the strongest consumer spending seen in three years.
Consumers spent more on services, specifically healthcare, which helped move the expansion forward.
Q1 2014 GDP could experience a pull back due to harsh weather conditions in the Northeast. On the bright side, fiscal headwinds have subsided.
7
-10.0%
-5.0%
0.0%
5.0%
10.0%
U.S. GDP Q-o-Q Trailing 4-Quarter Average
SVB Asset Management | Quarterly Economic Report Q1 2014
-1.0%
1.0%
3.0%
5.0%
Government Res Investment Inventories Net Exports Bus Fixed Investment Personal consumption exp GDP
Consumption Temporary Slow Down Consumer Sentiment – University of Michigan
Source: U.S. Bureau of Economic Analysis (BEA), Census.gov, University of Michigan / Thomson Reuters - Survey of Consumers, SVB Asset Management.
Retail & Food Services Sales Personal Consumption – % Change
Q1 spending activity pulled back due to extraordinary weather conditions.
Consumers were less optimistic towards the end of the quarter with consumer confidence falling to a four-month low.
Disposable incomes rose the most in February since September 2013 at 2.1 percent year-over-year.
Consumer spending expanded by 3.3 percent in the final quarter of 2013, the biggest increase in three years.
As the winter cold passes consumers will start to feel positive again.
8
40.0
60.0
80.0
100.0
120.0
Average
$5.0
$10.0
$15.0
$20.0
$25.0
$250.0
$300.0
$350.0
$400.0
$450.0
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%
SVB Asset Management | Quarterly Economic Report Q1 2014
Consumption Temporary Slow Down Personal Income
Source: U.S. Bureau of Economic Analysis (BEA), Federal Reserve, SVB Asset Management.
Personal Savings as % of Disposable Income
Household Net Worth
Personal incomes have increased steadily the first few months of Q1.
Savings rates as a percentage of disposable income have been hovering around 4.3 percent.
Post financial crisis household balance sheets have greatly improved.
Household net worth continues to be on the rise benefitting from higher home values and rising equity prices.
The net worth of U.S. households and non-profit groups continues to climb and is currently over $80 trillion, almost a 14 percent year-over-year increase.
9
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
Mon
thly
Per
cent
age
Cha
nge
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
$0.0
$15.0
$30.0
$45.0
$60.0
$75.0
$90.0
Bill
ions
SVB Asset Management | Quarterly Economic Report Q1 2014
Employment Slowly Improving Employment Landscape
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.
Full-Time Employment
Job growth remains slow and steady. It has been 3 ½ years since monthly payroll growth was negative.
The Fed has never raised rates with the underemployment rate (U-6) above 10 percent. It currently lies at 12.6 percent.
Full-time jobs have been replacing part-time jobs for about two years, but total full-time jobs remain lower than the 2007 peak.
Worker attitudes continue to mend, evidenced by improving trend in number of “discouraged workers.”
10
-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)
SVB Asset Management | Quarterly Economic Report Q1 2014
0.0
5,000.0
10,000.0
50,000.0
70,000.0
90,000.0
110,000.0
130,000.0
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
1,000.0 1,200.0 1,400.0
Thou
sand
s
Discouraged Workers Not in Labor Force
Employment Slowly Improving Conference Board Consumer Confidence
Source: U.S. Bureau of Labor Statistics (BLS), SVB Asset Management.
ADP Employment Survey by Industry (Rebased to 100)
Hires and Quits Remain Depressed Consumers are gaining confidence in the jobs market with “jobs plentiful” trending up and “jobs hard to get” trending down.
Hires and quits remain low, but are also trending in the right direction. Greater turnover is a strong sign of job market confidence.
ADP survey shows small companies have already replaced all dismissed workers during the downturn, while larger companies have more to go.
11
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
Job Hire Rate Job Quit Rate
SVB Asset Management | Quarterly Economic Report Q1 2014
0.0%
20.0%
40.0%
60.0%
0.0%
10.0%
20.0%
30.0%
40.0%
Conference Board Consumer Confidence Jobs Plentiful Conference Board Consumer Confidence Jobs Hard to Get
85.0
90.0
95.0
100.0
105.0
1-49 50-499 500+
U.S. Housing Market Plugging Along Home Sales & Supply
Source: National Association of Home Builders (NAHB), Census.gov, S&P, and SVB Asset Management.
Housing Starts Home Prices – Indexed to 100
Total housing sales have suffered from recent uptick in rates.
Housing starts have improved recently, but have far to go given continued population growth. Starts are most important to the overall economy due to associated purchases and economic transactions.
Home prices remain in an upward trend, but momentum has paused recently. If employment continues to grow, look for housing statistics to also continue moving upward.
12
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
SVB Asset Management | Quarterly Economic Report Q1 2014
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
U.S. Housing Market Plugging Along Homeownership Rate
Source: Census.gov, National Association of Realtors and SVB Asset Management.
Housing Affordability Composite Index
Home Ownership and Foreclosures The homeownership rate seems to be bottoming, providing significant support for all aspects of the housing sector.
Home affordability has struggled in the recent quarter. However, it would take a significant jump in mortgage rates to make home ownership markedly less affordable.
Foreclosures continue to drop quickly as resolutions to REO holdings are offered by alternative investors.
13
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
100.0
150.0
200.0
250.0
Affo
rdab
ility
Inde
x
Housing Affordability 30 Year Fixed Mortgage Rates
62.0%
64.0%
66.0%
68.0%
70.0%
SVB Asset Management | Quarterly Economic Report Q1 2014
0.0%
2.0%
4.0%
6.0%
60.0%
65.0%
70.0%
Homeownership Quarterly Rate Foreclosures as a % of Total Loans
Inflation Still Nowhere In Sight Component Distribution
Source: U.S. Bureau of Economic Analysis (BEA), U.S. Bureau of Labor Statistics (BLS) and SVB Asset Management.
Core PCE - % Change from Prior Year
Consumer Price Index - % Change from Prior Year Producer Price Index
14
-5.0%
0.0%
5.0%
10.0%
15.0%
CPI Ex Food & Energy CPI
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
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
SVB Asset Management | Quarterly Economic Report Q1 2014
41.5%
16.4%
14.9%
7.6%
7.1% 5.8%
2.7% 4.1%
Housing
Transportation
Food & Bev.
Medical Care
Educ. & Comm.
Recreation
Apparel less footwear
Other
CPI Components 12-month ChangeFood & Bev. 1.4%Housing 2.5%Apparel less Footw ea -0.4%Transportation -2.2%Medical Care 2.3%Recreation 0.3%Educ. & Comm. 1.1%Other 1.9%Headline CPI 1.1%Less:
Energy -2.5%Food 1.4%
Core CPI 1.6%
Inflation Still Nowhere In Sight Wage Growth – Average Hourly Earnings
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.
Crude Oil – Spot & Futures
Univ. of Michigan Survey of Inflation Expectations Core PCE continues to be well below the Fed’s target of 2 percent.
The Fed has acknowledged that inflation has been running below its long-term objective.
Despite being on the tapering track, the Fed is still open to accommodative monetary policy.
The Fed plans to monitor inflation developments carefully in search of evidence that inflation will move towards its target.
15
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
Ann
ual P
erce
ntag
e C
hang
e
$0.0
$50.0
$100.0
$150.0
Pric
e pe
r Bar
rel
Crude Oil Crude Oil Futures
SVB Asset Management | Quarterly Economic Report Q1 2014
1.5%
2.5%
3.5%
4.5%
5.5%
1 Year Ahead 5-10 Years Ahead
The Federal Reserve
Federal Reserve Diminished Returns Are Record Low Mortgage Rates Helping?
Source: National Association of Home Builders (NAHB), Census.gov, S&P, and SVB Asset Management.
Will the Wealth Effect be Sustainable? Low Participation Rate Impacts the Unemployment Rate
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.
Mortgage rates are still at very low levels even though they have been ticking up as the economy improves and the end of QE is in sight.
The unemployment rate has been dropping, but largely due to a drop in the participation rate. The participation rate peaked in 2000.
As the Fed moves towards ending quantitative easing the markets will pull back.
17
Thou
sand
s
600
900
1,200
1,500
1,800
2,100
$150.0
$170.0
$190.0
$210.0
$230.0
$250.0
Home Prices (LHS) S&P 500 (RHS)
SVB Asset Management | Quarterly Economic Report Q1 2014
0.0%
5.0%
10.0%
15.0%
62.0% 63.0% 64.0% 65.0% 66.0% 67.0% 68.0%
Labour Force Participation Rate (LHS) Unemployment Rate (RHS)
0.0%
2.0%
4.0%
6.0%
8.0%
$11.0
$12.0
$13.0
$14.0
$15.0
Bill
ions
Mortgage Outstanding (LHS) 30 Year Fixed Mortgage Rates (RHS) 10 Year Treasury (RHS)
Federal Reserve on the Taper Track
Tapering is on a roll, currently at the pace of $10 billion a month. Despite clear rhetoric that there is no pre-set course, if the economy continues to improve this latest round of QE will end by fall.
In the March meeting the Committee did away with the 6.5 percent unemployment rate threshold. In the place of an unemployment target the Fed added a more qualitative approach to forward guidance. This change will make communications from the Fed less clear.
Fed Chair, Janet Yellen, also announced in the March statement that the Fed remains committed to the 2 percent inflation target.
The recent changes to monetary policy created some volatility in markets and more is expected as the year passes.
Source: Federal Reserve and SVB Asset Management.
Recent Balance Sheet Trends
18 SVB Asset Management | Quarterly Economic Report Q1 2014
$0.0
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
$3.5
$4.0
Trill
ions
Other Fed Reserve Assets Central Liquidity Swaps Other Aurora Maiden Lane III Maiden Lane II Maiden Lane I TALF AIG Seasonal Credit Secondary Credit Primary Credit Other Loans Treasury Currency Outstanding Special Drawing Gold Stock MBS Federal Agency Debt Securities U.S. Treasury Securities
Special Topic: U.S. Banks’ Balance Sheets
U.S. Banks’ Balance Sheet Aftermath of Crisis
Source: FDIC, SVB Asset Management
FDIC Banks’ Loans to Deposits Ratio vs. Securities Held on Balance Sheet
20 SVB Asset Management | Quarterly Economic Report Q3 2013
70.0%
72.0%
74.0%
76.0%
78.0%
80.0%
82.0%
84.0%
86.0%
88.0%
$2.0
$2.2
$2.4
$2.6
$2.8
$3.0
$3.2
Tril
lions
Securities (LHS) Loans to Deposits (RHS)
At the short end of the curve, financials make up a large percentage of the securities outstanding.
Banks have taken strides to improve their balance sheet position since the height of the financial crisis.
Cognizant of the fact that liquidity was the first issue of the crisis, most banks sought to improve the liquidity of their balance sheet.
One key ratio, the loans to deposits ratio, improved markedly from 86.4 percent as of early 2009 to 70.5 percent as of December 2013.
With limited room for loan growth, most banks parked the increased deposits in securities, which grew from $2.2 trillion to $3.0 trillion in five years.
U.S. Banks’ Balance Sheet What Happens if Rates Rise? Impact of Upward Interest Movements on Securities Portfolio
Source: FDIC, SVB Asset Management’s Estimates
Average annual net income for the last five years since the crisis was $95.8 billion for the FDIC banks.
Assume a portfolio duration of 4.7 years on the securities portfolio of all FDIC securities.
It will take an estimated 68 basis points increase in interest rates and will take out the entire year’s of profits for the banks.
Banks will need to expand earnings by one and a half to sustain a parallel upward shift of 100 basis points to the yield curve without impacting capital ratios.
With the need to maintain strong capital ratios and a Tier-1 leverage ratio of 9.41 percent as of December 2013, there is limited room to maneuver.
However, we note that the losses are unrealized losses unless the banks are forced to exit out of their positions.
21 SVB Asset Management | Quarterly Economic Report Q3 2013
$0.0
$50.0
$100.0
$150.0
$200.0
$250.0
$300.0
$350.0
$400.0
$450.0
50 100 150 200 250 300
Bill
ions
Basis Points Potential Unrealized Loss Average Annual Profit
68 bps
U.S. Banks’ Balance Sheet The Accounting Shift Banks Shifting from Available for Sale to Hold-to-Maturity
Source: FDIC, SVB Asset Management
AFS HTM
Guideline Generally default category Intend to buy and hold until fixed future maturity date
Valuation Marked to market Original cost and amortized/ accrete as required
Change in Fair Value
Attribute gains and losses through stockholders equity
No impact
Drawback Fluctuations in capital levels depending on market movements
Banks unable to sell until maturity date due to tainting issue
Available for Sale (AFS) vs. Hold to Maturity (HTM) Size of U.S. Tri-Repo Market based on Collateral Value
To mitigate the impact of probable interest rate increase, banks are beginning to shift securities into the HTM bucket.
This will prevent banks from being required to report fluctuations in market value in their capital levels.
A drawback is that banks would be unable to sell the securities. However, banks can rely on the repo market and other ways to obtain liquidity from these high quality assets.
22 SVB Asset Management | Quarterly Economic Report Q3 2013
0.0%
5.0%
10.0%
15.0%
20.0%
78.0% 80.0% 82.0% 84.0% 86.0% 88.0% 90.0% 92.0% 94.0%
% of AFS of Securities (LHS) % of HTM of Securities (RHS)
Source: FDIC, Federal Reserve Bank New York, SVB Asset Management
$0.0
$0.5
$1.0
$1.5
$2.0
$2.5
Trill
ions
Markets & Performance
Funds Flow Bond Funds Refuel
Source: Bloomberg , Investment Company Institute, MSCI, and SVB Asset Management.
Equity Flows & Stock Performance
Net New Fund Flows Money Market Fund Flows
Outflows from bond funds into equity funds continued until the end of Q1 2014 where bond funds began to see increased inflows.
Equity inflows continued to outpace returns as investors continued to look for high yielding investments in a low interest rate environment and the uncertainty of rising rates.
With the continued reduction of government bond purchases we expect less funds to flow into riskier assets and more into to less risky assets.
Money market fund flows have started to decline once again as the SEC inches closer to finalizing their regulatory reform on the industry.
24 SVB Asset Management | Quarterly Economic Report Q1 2014
-$80.0
-$40.0
$0.0
$40.0
Bill
ions
Total Equity Total Bond
-20.0%
-10.0%
0.0%
10.0%
20.0%
-$40.0
-$20.0
$0.0
$20.0
$40.0
Bill
ions
Net New Cash Flow (LHS) Total Return on Equities (RHS)
$2.4
$2.5
$2.5
$2.6
$2.6
$2.7
Trill
ions
MMF AUM
Bond Sector Spreads Low End of the Range
25
Source: Bloomberg, BoAML , Barcap Live, Citigroup and SVB Asset Management.
Spread Performance by Asset Class
SVB Asset Management | Quarterly Economic Report Q1 2014
Bond investors continue to look to the short end as a safe haven to hedge the risk of higher interest rates in the near future. Therefore, short-end yields for agencies, corporates and structured products will continue to be anchored on the low end.
Based on five-year averages, bond-spreads (over U.S. Treasuries) for each asset class are trading well below their averages and are right at or close to the lows of their respective ranges.
Near-term spread volatility is expected to be low as investors stay short of their benchmarks awaiting the Federal Reserve’s next move.
26
Source: Bloomberg, BoAML , Barcap Live, Citigroup and SVB Asset Management.
Total Return by Sector
SVB Asset Management | Quarterly Economic Report Q1 2014
Market Returns Juice From Spread Products
Year-to-date returns for U.S. Investment grade corporates is 0.41 percent in 2014, making this market the second best performer behind commercial mortgage-backed securities.
One- to three-year corporate bonds and Auto ABS continue to outperform U.S. Treasuries and agencies in the 1st quarter.
Additionally, these sectors have posted strong results as fundamentals remain favorable — near zero default rates and less supply.
Market Returns Income Still in Play
Income return is still the main driver of positive total returns for the bond markets.
Price returns continue to exhibit negative returns as higher benchmark rates impact bond pricing.
Source: Bloomberg, BoAML and SVB Asset Management.
27 SVB Asset Management | Quarterly Economic Report Q1 2014
Benchmark Performance
Investment Performance Where’s the Horsepower? Ticker Q1 2014 2013 2012 2011 2010 2009 2008 2007
Short Benchmarks 3-month Treasury Bill G0O1 0.012 0.073 0.111 0.103 0.126 0.207 2.057 5.004 3-month Citi/Salomon CD SBMMCD3 0.050 0.204 0.307 0.289 0.310 0.822 3.442 5.448 6-month Treasury Bill G0O2 0.044 0.180 0.171 0.268 0.365 0.579 3.582 5.607 6-month Cit/Salomon CD SBMMCD6 0.070 0.272 0.488 0.389 0.437 1.611 3.756 5.459 1-yr Treasury Bill G0O3 0.052 0.277 0.204 0.496 0.792 0.813 4.746 5.948 Treasury 1-3 yr Treasury G1O2 0.138 0.358 0.434 1.554 2.348 0.785 6.609 7.317 3-5 yr Treasury G2O2 0.427 -0.913 1.577 6.229 5.695 -0.672 12.153 9.836 Corporate/Govt (A Rated and Above) 1-3 yr Corp/Govt B1A0 0.246 0.705 1.478 1.562 2.818 3.835 4.693 6.872 3-5 yr Corp/Govt B2A0 0.698 -0.158 3.817 5.415 6.231 6.400 4.577 7.846 Agencies 1-3 yr Agencies G1P0 0.170 .0.424 0.847 1.536 2.338 2.189 7.034 6.735 3-5 yr Agencies G2P0 0.587 -0.531 2.588 5.290 4.900 3.223 8.971 8.261 Municipals - Tax Exempt 1-3 yr Pre-refunded U1AF 0.160 0.807 0.520 1.800 0.923 3.189 5.875 4.710 3-7 yr Pre-refunded U2AF 0.242 0.952 1.539 4.951 2.087 5.345 7.992 5.390 Auto Asset Backed Securities ABS, Autos, Fixed Rate, (1.45 yrs) R0U0 0.406 0.802 2.291 1.689 3.077 14.845 -0.682 5.723 Other Indices** Dow Jones Industrial Average INDU -0.266 23.591 7.257 5.544 11.023 3.116 -33.762 6.432 S&P 500 SPX 2.010 26.390 13.405 2.110 12.783 23.454 -38.486 3.530 NASD CCMP 2.190 34.198 15.906 -1.799 16.910 43.888 -40.541 9.812 MSCI World Index MXWO 1.362 21.478 13.184 -7.615 9.262 27.283 -42.081 7.093 CRB Index (Commodities) CRY 7.742 -5.837 -3.372 -8.264 15.430 23.563 -39.450 16.679
28
Source: Bloomberg, BoAML, Morgan Stanley. * Past performance is not a guarantee of future results. ** Analyzed returns
SVB Asset Management | Quarterly Economic Report Q1 2014
Commodities China Slows Down, While U.S. Speeds Up Crude Futures – Per Barrel
Source: Bloomberg and SVB Asset Management.
Gold Prices – An Ounce Iron Ore Futures – Per Ton
Following the decline in late 2013, commodities have begun to stabilize in 2014 as weather becomes a factor. Price volatility will be impacted by the U.S. recovery and continued interest rate uncertainty.
Domestic oil and gas production rose during 2013, decreasing demand for imports as fracking continues to increase supply. Oil price per barrel continues to hover around $100.
Iron ore prices have been volatile due to uncertain China demands and future iron ore surpluses in the region.
29 SVB Asset Management | Quarterly Economic Report Q4 2013-
$80.0
$90.0
$100.0
$110.0
$120.0
$1,200.0
$1,400.0
$1,600.0
$1,800.0
$100.0
$120.0
$140.0
$160.0
Loan Market Fundamentals
Source: Thomson Reuters Loan Pricing Corp and SVB Financial Group
Credit Spreads Continue to Run Below 2009 Peak
Fundamentals Remain Steady 3-Month LIBOR Remains at Historic Lows
Credit spreads have fallen since the 5.6 percent peak in January 2009, but remain higher than the sub-2.0 percent levels before the financial crisis.
Lenders are still deciphering the impact on the leveraged loan market a year after the finalized Leveraged Lending Guidance was put in place, as well as assessing the implications for internal practices. It is unclear how the regulators are applying the guidance and what consequences or penalties will be imposed if lenders fall short.
Secondary loan prices continue to peak in the first quarter of 2014, at levels not seen since late 2009.
30 SVB Asset Management | Quarterly Economic Report Q1 2014
65.0
75.0
85.0
95.0
105.0
LPC LCDX (Secondary Loan Price Index - Par = 100)
0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 3 Month LIBOR
February 2014 0.26%
0.0%
2.0%
4.0%
6.0%
10 YR BBB Yield - 10 YR Treasury Yield
February 2014 2.4%
January 2009 5.6%
High Yield Market Fundamentals High Yield Funds Dip Notably in June
Source: Thomson Reuters Loan Pricing Corp., Lipper FMI and SVB Financial Group
Issuance conditions remain optimal. While volatile, last week benchmark Treasury yields were still below recent highs. According to the BAML HY Master II Index, HY spreads have contracted to the year’s lowest level, a level not seen since July 2007.
Lipper reported a $196 million outflow from high-yield funds in the week that ended on March 26, with a heavy ETF outflow of $426 million, erasing a $230 million inflow to mutual funds. However, inflows in the year-to-date totaled $2.8 billion.
Lower-rated credits took advantage of investors' hunger for yield at the end the first quarter 2014. Accounting for 42 percent of the week’s volume, three triple-C rated deals hit the market. In the first two weeks of March, double-B rated deals led the way and accounted for 68 percent of issuance volume while triple-C rated deals made up just $1 billion of the first half of the month’s $17.5 billion issuance volume.
High Yield Take-Outs of Bank Debt
31 SVB Asset Management | Quarterly Economic Report Q1 2014
$0.0
$10.0
$20.0
$30.0
$40.0
$50.0
$60.0
Issu
ance
($B
illio
ns)
$0.0
$100.0
$200.0
$300.0
$400.0
Net
Ass
ets
($B
illio
ns)
Loan Funds HY Bond Funds
Overall Loan Market Overview Historical Syndicated Loan Volumes
Source: Thomson Reuters Loan Pricing Corp and SVB Financial Group
Excluding refinancings, leveraged loan volume stood at a seven-year high of $102.2 billion in the first quarter, fortified by $83.1 billion issuance of institutional paper, up from $77.4 billion/$53 billion in the fourth quarter and $71.1 billion/$56.2 billion during the first quarter of 2013.
Strong market technicals signaled robust lender capacity and demand for yield as a series of cross-border syndications and large M&A credits worked through a market heavily weighted toward opportunistic refinancings in 2013. Despite the record issuance however, just over 36 percent, or $1.45 billion, represented new loan assets, compared to 55 percent in 2007.
M&A-related loan volume flourished in the first quarter, inching to a post-2007 high of $65.9 billion, including $53.5 billion of institutional tranches, from $61.4 billion/$39.6 billion during the fourth quarter of 2013.
The core issues in 2014 continue to be refinancing and releveraging. Refinancing activity will remain strong amid record low rates and releveraging related activity to finance LBOs should continue to increase.
Pro Rata Lending Exceeds Institutional Loans
32 SVB Asset Management | Quarterly Economic Report Q1 2014
$0.0
$500.0
$1,000.0
$1,500.0
$2,000.0
$2,500.0
Issu
ance
($B
illio
ns)
Leverage I-Grade Other
$0.0 $20.0 $40.0 $60.0 $80.0
$100.0 $120.0 $140.0 $160.0
Leve
rage
d lo
an v
olum
e ($
Bill
ions
)
Pro rata Institutional
Global Economy
Eurozone Real GDP
Source: Eurostat, MarkIt, Bloomberg and SVB Asset Management.
Discontinuous growth within the Euro zone is transitioning to steady growth, albeit at marginal levels. Fourth quarter GDP was positive for the first time in almost two years. Germany, France, and Portugal registered gains, while Italy, Spain, and Greece remained in contraction.
The Euro zone Composite PMI index for March 2014 denoted growth for the ninth consecutive month, with indications the expansion will continue in the upcoming months, as new orders and backlogs increased at a healthy pace.
Euro zone financial conditions continue to improve, allowing Greece to potentially return to the bond market with an offering by the middle of the year.
Crimea’s defection to Russia and fears of additional part of Ukraine falling to Russian control heightened geopolitical risk, but will not be enough to materially derail continued economic progress as a political solution is expected.
An upset of the banking sector could be an upcoming speed bump as the EU banking stress test may reveal additional bad loans and push banks to raise significant additional capital.
Eurozone Composite PMI
SVB Asset Management | Quarterly Economic Report Q1 2014 34
Europe Ending Discontinuous Growth
Europe Euro & Pound May Diverge Currency Performance
Source: Eurostat, Bloomberg and SVB Asset Management.
Sustained economic activity continues to push the GBP higher, while the EUR has been kept afloat by low inflation, improving financial stability, and providing a persistent current account surplus. Domestic consumption is largely driving economic activity in the UK, while the Euro zone is more reliant on exports.
UK home price appreciation continued to intensify, reaching 9.5 percent in March 2014. The housing market is supporting solid retail sales, with spending on food and internet purchases particularly strong. Manufacturing and service activity continued to expand, though volatility in emerging markets helped soften export activity. The BOE refocused forward guidance from unemployment to economic slack.
The euro remains firm even as the ECB threatens additional easing if inflation endures below its 2014 target of 1 percent. Inflation preliminarily measured 0.5 percent in March 2014, though the low level is primarily attributed to fickle energy and food components. Generally, a current account surplus is keeping the euro at levels higher than the ECB may desire, and compel action later this year.
The EUR is expected to linger within the 2013 range, though it is poised to fall due to potential ECB easing and a stronger U.S. economy. Conversely, the GBP risks drifting marginally higher due to anticipation of a BOE rate hike late in the year. The BOE may refrain if inflation remains below 2 percent, even as unemployment and economic slack shrinks.
Euro Zone Inflation
SVB Asset Management | Quarterly Economic Report Q1 2014 35
EU
R /
US
D
GB
P/U
SD
China Growth Decline Quickens Chinese Yuan
Source: National Bureau of Statistics of China, Markit, Bloomberg and SVB Asset Management.
Trade Balance Manufacturing PMI
The PBOC doubled the range to 2 percent that the Yuan may stray from the daily reference rate, to increase flexibility of investment capital movement.
The Yuan declined the most (on a quarterly basis) in 20 years during the first quarter of 2014 as weak manufacturing, retail sales and export data inflamed slower growth fears.
The government officially set its growth target at 7.5 percent, similar to last year. Fiscal stimulus to subsidize meeting the growth target may help to slow the Yuan’s fall.
36 SVB Asset Management | Quarterly Economic Report Q1 2014
6
6.1
6.2
6.3
6.4
CN
Y/U
SD
-$25.0
$25.0
$75.0
$125.0
$175.0
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14
Bill
ions
US
D
Trade Balance Exports Imports
>50
= E
xpan
sion
; <5
0 =
Con
tract
ion
Asia Inflation Slowing Declining – Yen Continues, Rupee Moderates
Source: Japan Ministry of Internal Affairs and Communications, India Central Statistical Organisation, Bloomberg and SVB Asset Management.
India Consumer Price Index
Japan Household Spending Japan: The Bank of Japan (BOJ) took no new action at its March meeting and reiterated its commitment to the ‘Quantitative-Qualitative Easing’ (QQE) program. The BOJ reduced its view of exports while being more positive on industrial production and capital expenditures. A 3 percent sales tax hike that took effect in April may slow domestic demand, and brake inflation from moving towards the BOJ’s 2 percent target. This may push the BOJ to enact further measures, which, along with the Fed’s continued reduction of balance sheet growth, will prevent the yen from strengthening.
India: After hiking the repo rate 25 bps in January the third interest rate hike in four meetings, the Reserve Bank of India (RBI) refrained from increasing interest rates at its April meeting as a drop in vegetable prices helped to moderate inflation to 8.1 percent in February. Growth remains vulnerable after hitting a decade low in March. Rupee volatility may decline in the near-term if inflation continues to moderate and election results in May avoids political uncertainty.
37 SVB Asset Management | Quarterly Economic Report Q1 2014
90.0
95.0
100.0
105.0
53.0
58.0
63.0
68.0
JPY
/US
D
INR
/US
D
INR JPY
-8.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0%
The U.S. Dollar Upside Risk 1-Year Implied 1-Year Forward Treasury Rate
Source: Bloomberg and SVB Asset Management.
The Federal Reserve continued to reduce its bond purchase program at its March 2014 meeting. The pace of reduction is anticipated to be maintained throughout 2014, which will effectively end ‘QE3’ by November 2014.
The Fed may next reduce or end its policy to reinvest principal payments from its agency debt and mortgage securities holdings. The ending of reinvestments would effective contract the Fed’s balance sheet and tighten monetary conditions without raising the Fed funds rate.
Forward guidance provided by the Fed at its March 2014 meeting, along with comments by Chair Janet Yellen, sparked a sell-off in Treasury rates from speculation that an interest rate hike may occur sooner than expected. Implied 1-year forward 1-year rate climbed to price in at least 50 basis points of higher rates by March 2015.
The federal funds rate may not change until the second half of 2015, despite strengthening economic fundamentals, as core inflation remains below target. The USD has strengthening upside risk, as U.S. growth (within the context of benign inflation) may outpace other developed countries, particularly the Euro zone.
DXY USD Index
SVB Asset Management | Quarterly Economic Report Q1 2014 38
78 79 80 81 82 83 84 85
DX
Y In
dex
Leve
l
Portfolio Management Strategy
Portfolio Strategy Tying It All Back
Short duration benchmark (3 & 6 month)
Intermediate duration benchmark (1 yr)
Long duration benchmark (2 yr+)
Duration Targets Longer than benchmark
Neutral to benchmark
Shorter than benchmark
Sector Overweights Financials, Commercial Paper, MMFs
Financials, Industrials, Commercial Paper
Short Maturity Financials, Long Maturity Industrials, ABS
Sector Underweights
Treasuries, Agencies, Industrials
Treasuries & Agencies
Agencies
40 SVB Asset Management | Quarterly Economic Report Q2 2013
2014 Portfolio Strategy Outlook We anticipate that the FOMC will continue their tapering of Treasury and mortgage-backed securities purchases, bringing an end to the large scale asset purchases (LSAP) by the end of the year. As we head into year end, the market views will shift focus from tapering to predicting the timing of the first federal funds rate hike.
Strong credit fundamentals persist which will benefit the corporate bond market.
There is strong institutional demand for corporate bonds even in a rising interest rate environment.
41 SVB Asset Management | Quarterly Economic Report Q1 2014
ABS Corporate Bonds: Industrial Sector
Sector Overview
We anticipate lower yields in the first half of 2014 and a gradual rise of rates into year end
Agency yields are right on top of comparable maturity Treasuries thereby not offering much incremental yield
End of first quarter 2014 Approximate Yields: - 2 yr Treasury: 0.42% - 2 yr Agency: 0.42%
Treasuries & Agencies
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 1st quarter 2014 spreads/yields: - 2 yr A-rated Industrials: ~+22 / ~0.65 % - 2 yr A-rated Industrials: ~+33 / ~0.75 %
Strong fundamentals for the auto and credit card ABS sectors
Very stable spreads
Active new issue and secondary markets
We favor prime auto ABS with durations under 2 years as they offer a yield pick-up over comparable AAA-rated securities and strong credit performance
End of first quarter 2014 spreads/yields: - 2 yr Auto ABS Spread: Swaps ~+17 / ~0.72 %
Corporate Bonds: Finance Sector
Banks and brokers offer the best value as both regulators and the industry are incentivized to build capital. Additionally, earnings continues to be strong
Active new issue market and very strong and liquid secondary market
In the short end, Financial companies account for close to 40 percent of issues outstanding
End of 1st quarter 2014 spreads/yields: - 2 yr A-rated Finance:
~+43 / ~0.85 % - 2 yr A-rated Finance:
~+60 / ~1.02 %
Our Team
42
Managing Director
Jeff Schnitz [email protected]
Chief Investment Officer
Joe Morgan, CFA [email protected]
Head of Credit Research
Melina Hadiwono, CFA [email protected]
Portfolio Managers
Eric Souza [email protected] Paula Solanes [email protected] Renuka Kumar, CFA [email protected] Jose Sevilla [email protected]
Credit and Risk
Sook Kuan Loh, CFA [email protected] Tim Lee, CFA [email protected] Kyle Balough [email protected]
Silicon Valley Bank Partners
Susan Winters Kelly Caviglia Priyanka Raju Girish Mallya Sudhakar Pattabiraman
Head of Portfolio Management
Ninh Chung [email protected]
SVB Asset Management | Quarterly Economic Report Q1 2014
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.
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©2014 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of FDIC and Federal Reserve System. SVB>, SVB>Find a way, SVB Financial Group, and Silicon Valley Bank are registered trademarks. SVB Asset Management, a registered investment advisor, is a non-bank affiliate of Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management are not FDIC insured, are not deposits or other obligations of Silicon Valley Bank, and may lose value. B_SAM-14-13308 Rev. 04-14-2014.
43 SVB Asset Management | Quarterly Economic Report Q1 2014
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