2015 Outlook
World Economies Rebuild as U.S. Growth Strengthens Investment leaders share what to expect in the year ahead.
2015 Outlook
World Economies Rebuild as U.S. Growth Strengthens
2015 Themes
World Economies Rebuild as U.S. Growth Strengthens
Independent affiliates offer their expertise and ideas for investing. The U.S. economy continues to grow. Job creation is solid, manufacturing remains steady and housing activity has stabilized. Inflation remains low. Consumer spending should be buoyed by reasonable income growth, a healthy stock market and lower energy prices. The Federal Reserve (Fed) begins raising the federal funds rate modestly. The Fed has ended quantitative easing and will likely start increasing the fed funds rate in 2015, which should result in rising bond yields in the short-term and greater equity volatility. Corporate capital expenditures (capex) remain steady. Economic expansion has been positive for corporate earnings, which have moved higher in recent years. The decline in energy prices is contributing to lower capex estimates moving forward. Areas around the globe work toward economic recovery. The European Central Bank (ECB) continues to support liquidity and fight deflation. Japanese fiscal and monetary policy will remain supportive. China is likely to maintain growth near its target levels, and many emerging markets are stabilizing.
U.S. Employment Has Reached an All-Time High 140 Employment (millions of jobs)
135 130 125
We are experiencing the longest period of 200,000+ monthly job additions in 17 years.
120 115 110 105 100 1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Source: Cornerstone Macro. Data from 1/1/88 to 10/31/14. Used with permission. Shaded areas represent recessions.
2 NOT FDIC INSURED  NO BANK GUARANTEE  MAY LOSE VALUE
2010
2012
2014
World Economies Rebuild as U.S. Growth Strengthens
2015 Outlook
Expect the Municipal Market to Stay Resilient “Credit spreads are still relatively wide for taking on credit risk in the municipal market. We think good value exists.” — John Miller, Nuveen Asset Management
Municipal bonds performed well in 2014 despite forecasts of higher rates. Much of this performance was a return to normalization after 2013 outflows, in addition to investor concerns over mixed domestic economic data and global political uncertainty. The likelihood of contagion risk and negative effects on fund flows appears lower due to the evolution of conditions in Detroit and Puerto Rico. Positive general credit trends mean the par value of municipal bonds defaulting for 2014 has fallen to pre-2008 levels.1 We do not anticipate substantial capital appreciation based on further drops in interest rates. Nevertheless, opportunities in high yield municipals exist due to better credit fundamentals, potential spread narrowing, relatively high municipal-toTreasury ratios and positive supply/demand balance. These features should help support the market if interest rate volatility increases.
Investing Ideas ▪▪ Municipal yield curve. The steep yield curve is attractive for those who can invest in maturities longer than 10 to 15 years. ▪▪ Credit quality. Below investment grade and non-rated bonds present value, as these securities tend to trade more inefficiently than higher quality bonds. ▪▪ Essential service sectors. Water and sewer bonds, airports, toll roads, hospitals, schools and real estate projects present opportunities.
Municipals Are Relatively Inexpensive Versus Treasuries 10-Year AAA/UST Ratio 30-Year AAA/UST Ratio
10-Year Ratio Average 30-Year Ratio Average
200%
150%
Average Ratios Since 1984 30-year bond ratio: 92% 10-year bond ratio: 84%
Current 30-Year Ratio: 104%
100%
Municipals offer roughly the same yields as Treasuries but with additional tax benefits.2
Current 10-Year Ratio: 96%
50% 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Data Source: Bloomberg. Fair value MMD Municipal 10- and 30-Year Index AAA General Obligation bonds, 10- and 30-year U.S. Treasury yields. Represents the relative value of municipal yields to Treasury yields. Past performance is no guarantee of future results. Data from 1/1/84 to 11/30/14. 1 Industry Overview, Municipals Weekly, Bank of America/ Merrill Lynch Research, September 23, 2014. Latest data available. Data represents defaults on the entire universe of bonds, both rated and unrated. 2 Some income may be subject to state and local taxes and to the federal alternative minimum tax (AMT). Capital gains, if any, are subject to tax.
nuveen investments | 3
2015 Outlook
World Economies Rebuild as U.S. Growth Strengthens
Fixed Income Requires Flexibility “High yield corporate bonds can generate significant income with moderate interest rate risk and steady fundamentals.” — Tony Rodriguez, Nuveen Asset Management
The Fed is expected to begin hiking the fed funds rate in 2015. With little inflationary pressure, rate hikes should be incremental and deliberate, based on the outlook for growth and inflation. In contrast, the Bank of Japan recently increased its asset purchase targets, and the ECB plans to continue expanding its balance sheet. We believe the yield curve should continue to flatten, with short rates rising more than long rates, as overall rates drift modestly higher. The short and intermediate parts of the curve will likely underperform as we approach Fed policy normalization.
“We are constructive on corporate credit given company fundamentals remain stable and default rates stay near historical lows.” — Gunther Stein, Symphony
Central banks are continuing monetary easing efforts around the globe, contributing to broad market liquidity. However, it is important to distinguish market segments. High yield bonds and floating rate loans continue to be inefficient asset classes, subject to large technical impacts from supply/demand imbalances. Continued bouts of volatility will likely affect the liquidity of these markets, but overall we remain constructive on credit due to the current state of underlying corporate fundamentals.
While bonds have a tight relationship with interest rate movements, income dominates total return over longer periods of time.
Percent of Total Return Generated by Income
History Demonstrates that Rates Are Not the Biggest Return Driver 91.3%
93.2%
9/30/09 - 9/30/14
1/30/76 - 9/30/14
80.0%
Barclays Aggregate Bond Index Total Return 4.1%
7.9%
9/30/09 - 9/30/14
91.3%
1/31/93 - 9/30/14
Barclays U.S. High Yield 2% Issuer Capped Index
10.5%
8.0%
Data Source: Barclays. Data as of 9/30/14. Chart shows the percent of annualized total return derived from coupon return (as opposed to price appreciation). The Barclays Aggregate Bond Index has an inception date of 1/1/76. The Barclays U.S. High Yield 2% Issuer Capped Index has an inception date of 1/1/93. The index returns presented are for illustration purposes only and do not represent or predict performance of any Nuveen Investments product. Indices are unmanaged and unavailable for direct investment. Past performance is no guarantee of future results.
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World Economies Rebuild as U.S. Growth Strengthens
2015 Outlook
Investing Ideas ▪▪ Flexible, multi-sector income portfolios. Markets may soon favor bottom-up analysis, with issue and credit selection being the primary drivers of return. Broad, flexible portfolios use sector and asset class rotation to capitalize on opportunities. ▪▪ Defensively position for rising rates. A period of rising rates should benefit active yield curve management. Diversification across the curve allows investors to reinvest maturing bonds at higher interest rates. ▪▪ Higher income sectors. Income and sector exposure may be more important components of bond returns than interest rates. Consider higher yielding investment grade corporates, high yield bonds, bank loans, preferred stock and select non-U.S. market issues.
“By building a portfolio that is flexible in nature using different asset classes, investors can potentially achieve an attractive yield and mitigate risk in a rising interest rate environment.” — Mike Carne, NWQ
▪▪ Manage interest rate risk. Evaluating historical beta (volatility relative to the market) and correlations can help address rate sensitivity. Dividend-paying equities have typically shown lower volatility, along with lower correlation to Treasuries. This may help balance traditional fixed income holdings.
Reversal of High Yield Performance Highlights the Need for Credit Research
2013
BB-Rated (higher quality) CCC-Rated (lower quality)
2014
BB-Rated (higher quality) CCC-Rated (lower quality)
Cumulative Returns (%)
15%
Unlike 2013, higher quality outperformed lower quality in 2014 due to increased volatility.
12% 9% 6% 3% 0% Jan
Mar
June
Sept
Dec
Data Source: Bank of America Merrill Lynch. Data from 1/1/13 to 11/30/14. Data represents BB-rated and CCC-rated bonds that are included in the BofA Merrill Lynch High Yield Master II Index. Investors cannot invest in an index. Past performance does not guarantee future results.
“As we envision some level of volatility in 2015, we are cautious on individual companies and will continue to trade tactically to capture opportunities.” — Gunther Stein, Symphony
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2015 Outlook
World Economies Rebuild as U.S. Growth Strengthens
The Bull Market Still Has Legs “Equities should produce more modest results than in recent years, but also show continued strength compared to other asset classes.” — Bob Doll, Nuveen Asset Management
U.S. economic growth is expected to continue accelerating, from an average of roughly 2% since the Great Recession to approximately 3%.3 Consumers are spending more, encouraged by lower energy prices and low interest rates. And the labor market is improving, with job creation at its fastest pace in 15 years.4
“Longer term, the opportunity for large cap growth stocks on an absolute and relative basis is compelling.” — Justin Kelly, Winslow
As the economy strengthens, U.S. companies should prosper. These economic dynamics – combined with innovation in ecommerce, social media and biotechnology – have fueled the growth sectors. Corporate cash is the highest in two decades5 and companies have room to pay out more earnings in dividends. Payout ratios are now just 36%, well below the 30-year average of 46%.6 U.S. equity markets will likely grind higher going forward, with average annual returns in the mid-to-high single digits. Strengthening economic growth, strong earnings, healthy balance sheets, low inflation and accommodative global monetary policy is a recipe for continued appreciation in stock prices. We are constructive on U.S. equities, but expect volatility to increase as the Fed begins to increase rates.
Earnings Growth Is Expected to Trend Higher Again Longer Term
S&P 500 EPS Growth (%)
19%
18% 14% 12% 9% 9%
10%
9% 7%
7%
6% 6% 4%
5%
9%
8% 4%
5% 5%
1% 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 Estimated Data Source: RBC Capital Markets, LLC. Data as of 12/18/14. Bottom up estimates. Used with permission.
3 U.S. Department of Commerce. 4 Bureau of Labor Statistics. 5 FactSet as of 12/31/13. 6 Standard & Poor’s. Data as of 6/30/84 – 6/30/14. Most recent quarter-end data available.
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World Economies Rebuild as U.S. Growth Strengthens
2015 Outlook
Investing Ideas ▪▪ Companies with high levels of free cash flow appear well-positioned because they can raise dividends, buy back shares and reinvest in their businesses. ▪▪ Dividend-paying companies may offer a more conservative way to participate in equity markets, as historically they have remained competitive through various market cycles. ▪▪ Companies with three types of earnings growth are attractive, including long-term sustainable, cyclical and faster-growing. Emphasize long-term sustainable growth companies and those in newer industries that are growing rapidly through market share gains. ▪▪ Many small and mid cap equities have had recent operational disappointments, pressuring valuations. This seems transitory, and we see opportunities across the capitalization spectrum in a variety of sectors. We believe selectivity remains critical.
Dividend Growers Have Performed Well After Periods of Rising Rates Subsets of S&P 500® Index. All Rate Hikes Since 1972 Dividend Growers Dividend Cutters
Payers with No Change in Dividends Non-Dividend Payers
140
— Jon Bosse, NWQ
“Many small companies have adopted big company practices to improve operating efficiencies that could lead to upside potential in stock price.” — Phyllis Thomas, NWQ
Companies that pay dividends can help temper volatility and augment total return.
130 Index Returns
“Irrespective of the macro economic outlook, focusing on companies actively taking measures to liberate value has historically been a good strategy.”
120 110 100 90 80
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 Elapsed Months
Data Source: Ned Davis Research. Further distribution prohibited without prior permission. Copyright 2014 © Ned Davis Research, Inc. All rights reserved. Past performance is no guarantee of future results. Data shown is based on the average performance after all rate hikes since 1972 that occurred on the following dates: 1/15/73, 8/31/80, 4/9/84, 9/4/87, 2/4/94, 3/25/97, 6/30/99, 6/30/04. For a description of how each stock is grouped by dividend policy, see page 11.
“Dividend growers should fare well as rising rates would suggest a stronger economy and the potential for real earnings growth.” – Jim Boothe, Santa Barbara
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2015 Outlook
World Economies Rebuild as U.S. Growth Strengthens
World Markets Are Diverging “Valuations in non-U.S. developed markets are attractive. Companies with top line growth and self-help stories continue to be rewarded.” – Emily Alejos, Tradewinds
Global economic growth trends, interest rates, monetary policy and market returns are exhibiting increasing levels of divergence, suggesting that investors will need to remain flexible when scouring the world for investment ideas. United States. The U.S. economy is hardly experiencing a boom, but its growth is more reliable than other countries. The likelihood of tighter U.S. monetary policy acknowledges a healing economy that no longer requires zero-policy rates. Europe. Europe needs additional stimulus and deflation remains a concern. Investing in Europe might offer not only attractive yields and lower valuations, but also a chance to participate in an emerging European recovery. Japan. Japan has long been troubled by deflation concerns, and the Bank of Japan is aggressively easing. The third arrow of Abenomics (structural reform) is expected to be effective but incremental. While 2014 returns were disappointing, corporate standards are improving. Emerging Markets. The period of emerging market underperformance may be close to ending. Disparate valuations, interest rates and growth environments are intriguing. A strengthening U.S. dollar and falling commodity prices may lead to volatility, but these dislocations can create potential prospects.
“U.S. dollar strength may be a temporary headwind, but we believe commodities should lead as we enter this phase of the business cycle.” – Jon Spencer, Gresham Oil prices and commodities. Oil markets are set to achieve significant gains in 2015. Low prices are often the cure for low prices. Global oil demand is still growing and expected to increase by nearly 900,000 barrels per day in 2015, following a 1 million barrels per day increase in consumption in 2014.7 Capital expenditure on new oil production is being pared back, and new projects are being shelved. Geopolitical risks should be watched in some key supply areas, and fundamental instability in Russia and Venezuela has risen as prices have fallen. In addition, we are entering the part of the business cycle where commodities have historically led returns, as the U.S. economic expansion continues. 7 U.S. Energy Information Administration and International Energy Agency.
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World Economies Rebuild as U.S. Growth Strengthens
2015 Outlook
Investment Ideas ▪▪ Japan and select opportunities in Europe present attractive valuations, and companies with top line growth and self-help stories continue to be rewarded. ▪▪ South Korea, China, Malaysia and Brazil have strong demographics, and long-term secular growth points to long-term investments. Many shorter-term opportunities exist where improving company fundamentals are supported by a stable macroeconomic outlook. ▪▪ Strong dollar beneficiaries have gained from a tailwind of U.S. dollar strength. International company profitability has yet to be fully reflected in overseas market performance.
“We expect the global economy to gradually improve, led by a transition to a self-sustaining expansion in the United States and an eventual increase in global trade.” – Bob Doll, Nuveen Asset Management
▪▪ Global financials, technology and the automotive industry are inexpensive areas of the market with potential for increasing capital returns.
U.S. Trades at a Premium, but Provides Greater Return on Equity 3.0
Price-to-Book Value
United States 2.5
Global
2.0
ed rvalu Ove valued er Und
Consider valuation of broad markets on a price-to-book basis versus the return on equity.
Europe ex U.K. 1.5
1.0
Japan
8.0
Emerging Markets
9.0
10.0
11.0
12.0 13.0 Return on Equity
14.0
15.0
16.0
Data Source: MSCI, Bloomberg as of 11/30/14. Past performance is no guarantee of future results. Japan: MSCI Japan Index; Europe: MSCI Europe ex UK Index; Global: MSCI ACWI Index; Emerging Markets: MSCI Emerging Markets Index; United States: MSCI USA Index. See page 11 for index definitions. It is not possible to invest directly in an index.
“We see more opportunities overseas given that valuations reflect lower expectations.” Drew Thelen, Tradewinds
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2015 Outlook
Implications for Investors
Construct Portfolios to Reach Long-Term Goals
How can you connect what is happening in the markets with your own portfolio? What to Watch For
Expect the Municipal Market to Stay Resilient
Fixed Income Requires Flexibility
Interest rates: When credit spreads narrow, total return becomes more important
Bonds with higher yields may provide a performance cushion
Finding value: Higher yield potential
Bonds with wide credit spreads, typically high yield
Flexibility: Dynamic portfolios move as markets evolve
Less constrained and multi-asset class approaches
Rising rates: Seek higher income sectors
The Bull Market Still Has Legs
World Markets Are Diverging
Ideas to Consider
Higher yielding investment grade corporates, high yield bonds, bank loans, preferred stock and select non-U.S. markets
Free cash f low: Companies that return excess capital to investors
Growth of dividends or share buy-backs
Earnings growth: Above-average long-term growth
Companies expanding revenues and earnings
Long-life assets: May provide income and increase in value during expansions
Real estate and infrastructure
Selectivity: Instances of improving fundamentals and attractive valuations
Cautious investments in Japan and Europe
Favorable trends: Long-term secular growth
Select emerging markets with supportive economies and conditions
For more information, contact your financial advisor and visit nuveen.com.
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World Economies Rebuild as U.S. Growth Strengthens
GLOSSARY
The unmanaged S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The unmanaged Barclays High Yield Issuer 2% Capped Index tracks the performance of U.S. non-investmentgrade bonds and limits each issuer to 2% of the index. The unmanaged Barclays High Yield Municipal Bond Index is composed of municipal bonds rated below BBB/Baa. The unmanaged Barclays U.S. Aggregate Bond Index tracks the performance of U.S. investment grade bonds. The BofA Merrill Lynch High Yield Master II Index tracks the performance of below investment grade, U.S. dollar denominated corporate bonds publicly issued in the U.S. domestic market. The MSCI Europe ex UK Index captures large- and mid-cap representation across 14 Developed Markets (DM) countries in Europe. The MSCI Emerging Markets Index captures large- and mid-cap representation across 23 emerging markets countries. The MSCI ACWI Index captures large and mid-cap representation across 23 developed markets and 23 emerging markets countries. The MSCI Japan Index is designed to measure the performance of the large- and mid- cap segments of the Japan market. The MSCI USA Index is designed to measure the performance of the large- and mid cap segments of the U.S. market.
RISKS AND OTHER IMPORTANT CONSIDERATIONS Any reference to credit ratings refers to the highest rating given by one of the following national rating agencies: S&P, Moody’s or Fitch. Credit ratings are subject to change. AAA, AA, A and BBB are investment grade ratings; BB, B, CCC, CC, C and D are belowinvestment grade ratings. Past performance is no guarantee of future results. Prospective clients should review their investment objectives, risk tolerance, tax liability and liquidity needs before choosing a suitable investment style or manager. All investments carry a degree of risk, including loss of principal, and there is no assurance that any investment will provide positive performance over time. Value and growth style investing may fall out of favor and underperform other style investing during given periods. In addition, value style investing presents the risk that the holdings or securities may never reach their full market value because the market fails to recognize what the portfolio management team considers the true business value or because the portfolio management team has misjudged those values. Certain growth sectors or growth stocks may shift characteristics over a long market cycle and may not perform in line with stated benchmarks. Non-U.S. investing presents additional risks such as the potential for adverse political, currency, economic, social or regulatory developments in a country including lack of liquidity, excessive taxation, and differing legal and accounting standards. These risks are magnified in emerging and frontier markets. An investment in any municipal or taxable fixed income portfolio should be made with an understanding of the risks involved in investing in bonds. The value of the portfolio will fluctuate based on the value of the underlying securities. If sold prior to maturity, bonds are subject to gain/losses based on the level of interest rates, market conditions
2015 Outlook
Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Credit spread is the difference in yield between two securities that are identical in all respects except quality rating. Duration, expressed in years, measures the sensitivity of the price (the value of principal) of a fixed income investment to a change in interest rates. Price-to-Book (P/B) is the price per share of a stock divided by its book value (i.e., net worth) per share. For a fund, the ratio is the weighted average price/book ratio of the stocks in the fund’s portfolio. Return on Equity (ROE) is the amount of net income returned as a percentage of shareholders’ equity. Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. Chart from page 7: The Dividend Growers and Initiators category is a subset of U.S. Stocks (S&P 500® Index) as defined by Ned Davis Research, Inc. Each stock’s dividend policy is determined on a rolling 12-month basis. For example, a stock is classified as dividend-paying if it paid a cash dividend at any time during the previous 12 months. Dividend growers and initiators include stocks that raised their existing dividend or initiated a new dividend during the preceding 12 months. Dividend cutters or eliminators include stocks that lowered their existing dividend or stopped paying regular dividends during the preceding 12 months. A stock is reclassified only if its dividend policies change. The returns do not reflect the deduction of any fees, expenses or taxes. Returns for stocks that paid dividends assume reinvestment of all income. Investors cannot invest in an index.
and credit quality of the issuer. As interest rates rise, bond prices fall. Clients should contact their tax advisor regarding the suitability of tax-exempt investments in their portfolio. Income from municipal bonds may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on their state of residence. High yield or lower-rated taxable and municipal bonds carry greater credit risk and are subject to greater price volatility. Short selling involves certain risks, including additional costs of covering short positions and a possibility of unlimited loss on certain short sale positions. Derivative instruments for hedging purposes or as part of the investment strategy may involve certain costs and risks such as liquidity risk, interest rate risk, market risk, credit risk, management risk and the risk that a portfolio could not close out a position when it would be most advantageous to do so. This report is for informational purposes only and is not intended to predict or depict performance of any investment. The statements contained herein are based upon the opinions of Nuveen Investments and its affiliates, and the data available at the time of publication of this report, and there is no assurance that any predicted results will actually occur. Information and opinions discussed in this commentary may be superseded and we do not undertake to update such information. This information contains no recommendations to buy or sell any specific securities and should not be considered investment advice of any kind. This report should not be regarded by recipients as a substitute for the exercise of their own judgment. The analysis contained herein is based on numerous assumptions which may or may not occur. Certain information was obtained from third party sources which we believe to be reliable but are not guaranteed as to their accuracy or completeness.
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F I X E D I N C O M E | N O N -T R A D I T I O N A L S T R AT E G I E S
John V. Miller, CFA
Tony Rodriguez
Robert C. Doll, CFA
Gunther Stein
Michael J. Carne, CFA
Co-Head of Fixed Income
Co-Head of Fixed Income
Senior Portfolio Manager Chief Equity Strategist
Chief Executive Officer Chief Investment Officer
Portfolio Manager
symphony
nwq
nuveen asset management
Jon Bosse, CFA
Phyllis G. Thomas, CFA
James R. Boothe, CFA
Emily Alejos, CFA
Drew Thelen, CFA
Chief Investment Officer Co-President
Portfolio Manager Equity Analyst
Chief Investment Officer
Co-Chief Investment Officer
Co-Chief Investment Officer
santa barbara
tradewinds
nwq
Justin Kelly, CFA
Jonathan Spencer
Chief Investment Officer
President Chief Investment Officer
winslow capital
gresham
For more information, contact your financial advisor and visit nuveen.com. Nuveen Asset Management, LLC; Symphony Asset Management LLC; NWQ Investment Management Company, LLC; Santa Barbara Asset Management, LLC; Tradewinds Global Investors, LLC; Winslow Capital Management, LLC and Gresham Investment Management LLC are registered investment advisers and affiliates of Nuveen Investments, Inc. © 2014 Nuveen Investments, Inc. All rights reserved.
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