11-15_nam_wp_review-outlook-final2

Economic and Financial Market Review and Outlook Market Commentary

November 2015

THE ECONOMY PERFORMED IN LINE WITH OUR FORECAST IN 2015, expanding modestly with low inflation and low interest rates. The labor market essentially returned to full employment. Weak global growth and the resulting foreign stimulus measures weighed on commodity prices and further strengthened the dollar.

This contributed to uneven U.S. economic growth. Longer-term inflation expectations declined, delaying Federal Reserve (Fed) policy normalization thus far. Odds currently favor the Fed raising rates in December.

2016 Offers Modest Growth with Increasing Uncertainty In our view, key 2016 themes for the economy and markets include: ▪▪ Economic growth will continue to grow at a modest pace, limited by labor availability

and ongoing economic weakness abroad.

▪▪ Unemployment will gradually decline further, but is unlikely to fall below 4.5%.

▪▪ Energy prices should stabilize due to anticipated production cuts, but dollar strength and import prices will likely hold inflation below the Fed’s 2% target.

▪▪ The Fed will timidly move toward policy normalization. Assuming normalization begins in December, the Fed will likely limit 2016 rate increases to 50 basis points.

▪▪ Long-term interest rates will remain within the range of the past two years.

▪▪ Profit growth will again be constrained by dollar strength, weakness abroad, limited pricing power and incremental labor cost pressures.

▪▪ Market volatility will likely remain elevated.

These themes reflect our baseline views for the 2016 economy and reflect the following economic developments: ▪▪ Improved household formation rates.

▪▪ A favorable employment backdrop and incrementally improving wage growth.

▪▪ Reasonably strong consumer confidence and improved household balance sheets.

▪▪ Improved state and local government revenues and spending rates.

▪▪ An incremental lift to federal spending growth due to the recent budget agreement.

NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE

Keith Hembre, CFA Chief Economist and Investment Strategist, Head of Quantitative Strategies Nuveen Asset Management, LLC

Economic and Financial Market Review and Outlook

November 2015

▪▪ Export and cap-ex spending will not likely rebound quickly

However, divergences within the U.S. economy and circumstances abroad offer more sources of uncertainty in 2016 than in recent years, including:

given foreign economic conditions and recent profit trends.

▪▪ Domestic consumption and construction spending remain on a solid trajectory supporting broader economic growth. These segments will likely exhibit sensitivity to higher policy rates.

▪▪ The effects of the first Fed policy rate increase in

nearly 10 years.

▪▪ The success of China’s policy measures to stabilize

Historically, central banks don’t have a good track record of effectively and sustainably moving interest rates off the zero bound. Examples include actions by the European Central Bank (ECB) in 2011, Sweden in 2010, the Bank of Japan in 2000 and 2006 and the Fed in 1936. The Fed has likely considered these comparative episodes in its delay of normalization. Each situation is unique, but the similarities create concerns for the broader outlook, particularly given the circumstances in the industrial sector.

descending growth.

▪▪ Further fallout from the incomplete adjustment in the energy sector.

Exhibit 1: Full Employment Has Been Reached Unemployment Rate 15% 10%

Exhibit 2: Capital Expenditures May Caution Fed Policy 5% 0% 1970

1980

1990

2000

Year-Over-Year % Change

30% 2010

Source: Bureau of Labor Statistics. Data from 1/1/70 to 10/31/15.

Uncertainty Exists at Home and Abroad FEDERAL RESERVE POLICY. Futures markets currently factor in a two-thirds probability of the Fed beginning normalization in December. Although the Fed has dramatically reduced its guidance for policy actions over the past year, we continue to expect less tightening than the Fed’s forward guidance.

Non-Defense Capital Goods New Orders

20% 10% 0% -10% -20% -30% -40%

1995

2000

2005

2010

2015

Source: Bureau of Economic Analysis. Data from 1/1/93 to 9/30/15.

CHINA AND GLOBAL CONDITIONS. China’s economic performance sputtered through much of the year. This reflected structural issues and policy efforts focused on reorienting the economy from an export and investment driven growth model toward a more sustainable, domestic and demand-oriented economy.

Official GDP figures report growth of 6.9% through the third quarter, the weakest performance since 2009. Alternative measures suggest actual growth has been considerably lower.

While normalization is arguably long overdue and necessary, the effects of the first U.S. policy moves in nearly 10 years are uncertain, particularly given current uneven economic trends.

A number of indicators in the industrial sector are inconsistent with past tightening cycles: ▪▪ Non-defense capital goods orders dropped 7.5% in September versus the prior year. The Fed has not tightened policy with such weak capital goods orders in the past.

▪▪ U.S. exports declined 3.7% year-over-year in September, illustrating the effects of weak foreign conditions and dollar strength on domestic economic performance.

▪▪ Manufacturing and industrial sector growth stalled due to weak cap-ex and exports, along with elevated inventory levels.

As a result, policy makers shifted their focus from economic reform to economic growth during the summer months.

Since then, economic data has improved from consistently disappointing to mixed. Auto and retail sales improved due to stimulus measures, and bank lending accelerated as a result of reduced interest rates and lower required reserve ratios.

2

Economic and Financial Market Review and Outlook

November 2015

However, China’s five-year economic plan calls for 6.5% GDP growth for 2016-2020, which is considerably lower than the past 25 years. Deferring longer-term reforms to provide nearterm economic relief will make the inevitable transition of the Chinese economy more challenging.

ENERGY SECTOR ADJUSTMENT. Recent drilling activity data (based on the weekly rig count) continues to decline, but domestic oil production levels remain resilient and oil inventories are high.

Data suggests that production per rig accelerated throughout 2015. Buoyant production levels have suppressed crude oil prices longer than anticipated. As we move into 2016, producers’ 2015 price hedges will expire and we expect a more meaningful decline in production, which should eventually stabilize prices.

However, this will reduce domestic production, investment spending and employment in the energy sector. The drop in energy prices has been a significant positive for U.S. households and helps explain the strong consumption spending versus other economic segments. We expect this strength in consumption spending will likely diminish in 2016.

China’s structural growth deceleration reverberated through other emerging market economies that have significant links to China. Slower growth in China, and emerging markets more broadly, was the key factor in the sharp drop in industrial commodity prices in 2015.

China’s contribution to global economic growth has diminished, but Europe and Japan have not picked up the slack. The sluggish economic performance in these economies, which have considerable export exposure to China, has led the European Central Bank and the Bank of Japan to consider increasing ongoing quantitative easing programs. As a result, their respective currencies remain weak.

Outlook Contains Upside Risks We see two potential sources of upside risk to U.S. economic growth in 2016: ▪▪ China implements a larger and more effective stimulus than

Weak growth has pushed inflation lower in each of these economies. Declining inflation, along with depreciating local currencies, has led to a sharp decline in U.S. import prices.

Falling import prices have kept overall inflation low, benefiting domestic consumers and supporting real consumption growth.

But these forces have been a headwind for U.S. corporate profit growth and will likely affect hiring and investment decisions in 2016.

expected, triggering stronger global growth and relieving pressure on the dollar, energy prices and exports. China’s policies have moved in this direction but are likely to remain more incremental.

▪▪ Workers having a greater ability to command wage increases and drive faster consumption growth. This seems to be balanced by an outlook for moderating job growth.

Downside risks arising from Fed tightening, global weakness and further energy industry disruptions seem greater than upside risks over the next 12 to 24 months.

Exhibit 3: Non-Oil Import Prices Have Declined U.S. Import Prices (Ex-Oil) Year-Over-Year Change

10% 5% 0% -5% -10%

2005

2010

2015

Source: Bureau of Labor Statistics. Data from 1/1/03 to 10/31/15.

3

Economic and Financial Market Review and Outlook

November 2015

Our Forecast Remains Modestly Below Consensus Our 2016 estimates for GDP growth, unemployment and inflation run modestly below consensus. Consensus estimates have been overly optimistic in recent years, and we believe that will continue in 2016.

2015 (Estimated)

2016 (Forecast)

2016 Consensus1

Real GDP (Q4/Q4)

2.0%

1.5% - 2.0%

2.6%

Personal Consumption Expenditures

2.6%

1.5% - 2.5%

Investment

1.8%

1.0% - 3.0%

Net Exports

–$551 billion

–$610 billion

Government Spending

1.6%

1.5% - 2.5%

Unemployment Rate2

4.9%

4.5%

4.7%

Consumer Price Index

0.5%

1.3% - 1.8%

1.8%

Core Consumer Price Index

1.8%

1.4% - 1.9%

NA

Fed Funds Rate

0.25%

0.50% - 0.75%

1.25%

2

2

10-Year Treasury Yield

2.40%

2.00% - 3.00%

2.82%

Corporate Earnings (S&P Operating)

$108.00

$113.00

$126.943

Trade-Weighted Dollar2

$100.00

$95.00 - $105.00

2

1 Bloomberg and Blue Chip consensus forecasts, November 2015.

2 End of period level.

3 Standard & Poor’s, November 6, 2015.

Investment Strategy: Remain Nimble and Active We expect modest investment returns, heightened volatility and downside risks across asset classes to continue in 2016 based on our outlook for the economy and domestic policy. The following elements were key to our tactical asset allocation strategy in 2015: ▪▪ We favored large cap domestic equities versus domestic small caps. We believed

large caps would outperform small caps for a second consecutive year due to valuation differentials and the diminishing boost to earnings multiple expansion as Fed policy normalization looms.

▪▪ We were underweight emerging markets beginning mid-year, as we expected slowing growth in China and prospective Fed policy adjustments to weigh on emerging market currencies and local market performance.

▪▪ We were significantly overweight high yield municipals. This remained the most attractive fixed income market segment with relatively stable high income compared to other fixed income sectors.

▪▪ We remained underweight inflation protected strategies given global disinflationary pressures and the strength of the dollar; we held long dollar positions.

Broadly, these themes remain for 2016. We will likely see average volatility levels rise above 2015 levels. We think this will increase opportunities for active tactical allocation and active management more broadly.

▪▪ We continue to favor large cap domestic equities. We expect them to outperform small caps for a third year as the Fed tightens policy and the economic cycle matures.

Valuations remain favorable for large caps relative to small caps despite recent outperformance.

4

Economic and Financial Market Review and Outlook

November 2015

▪ We remain modestly overweight EAFE equities on the prospects of enhanced QE

in Europe and Japan. EAFE stock performance has been disappointing on a relative basis this year given the quantitative easing programs in Europe and Japan. European stocks remain below March levels when the program was implemented.

▪ We remain underweight emerging market equities, reflecting economic growth concerns and currency pressure.

▪ We continue to favor high yield municipals as the most attractive area within the fixed income markets, given an outlook for range-bound longer-term yields, the high income produced by the sector and relative credit strength.

▪ We remain underweight inflation protected strategies due to Fed tightening prospects, global disinflationary pressures and the strength of the dollar.

▪ We are waiting to increase exposure to commodities. Price levels are attractive, but we’ll await a larger production response to lower prices before moving forward. ▪

For more information, please consult with your financial advisor and visit nuveen.com.

Future is a financial contract obligating the buyer to purchase an asset (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price.

Inflation represented by the Consumer Price Index (CPI), reflecting the change in consumer prices determined monthly. Core inflation excludes food and energy.

SOURCES Payrolls U.S. Department of Labor Gross Domestic Product U.S. Department of Commerce

RISKS AND OTHER IMPORTANT CONSIDERATIONS

This information represents the opinion of Nuveen Asset Management, LLC and is not intended to be a forecast of future events and this is no guarantee of any future result. It is not intended to provide specific advice and should not be considered investment advice of any kind. Information was obtained from third party sources which we believe to be reliable but are not guaranteed as to their accuracy or completeness. This report contains no recommendations to buy or sell specific securities or investment products.

All investments carry a certain degree of risk, including possible loss of principal and there is no assurance that an investment will provide positive performance over any period of time.

There are specific risks associated with small company investments including higher volatility than large cap companies and limited resources. Investing internationally presents certain risks not associated with investing solely in the U.S., such as currency fluctuation, political and economic change, social unrest, changes in government relations, differences in accounting and the lesser degree of accurate public information available, foreign company risk, market risk and correlation risk. These risks can be exaggerated in emerging markets. Commodities markets historically have been extremely volatile, and the performance of securities and other instruments that provide exposure to those markets therefore also may be highly volatile.

Derivative securities may experience heightened interest rate risk. The use of derivatives

Business Inventories U.S. Department of Commerce S&P 500 Standard and Poor’s U.S. Treasury and U.S. and Foreign Government Bond Yields Bloomberg Treasury Spreads Bloomberg Oil Prices Bloomberg U.S. Dollar Index Bloomberg

presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. Securities in the real estate sector are greatly affected by economic downturns that may persist as well as changes in property values, taxes, and regulatory developments. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Credit risk refers to an issuers ability to make interest and principal payments when due. The guarantee provided by the U.S. government to treasury inflation protected securities relates only to the prompt payment of principal and interest and does not remove the market risks of investing in these securities. High yield bonds are speculative and along with unrated bonds may carry heightened credit risk, liquidity risk, and potential for default.

Investors should contact their tax advisor regarding the suitability of tax-exempt investments in their portfolio. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on state of residence.

It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager. Nuveen Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen Investments, Inc.

Nuveen Investments | 333 West Wacker Drive | Chicago, IL 60606 | 800.752.8700 | nuveen.com

12022-INV-M-12/15

GLOSSARY