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Our purpose: protect livelihoods and futures. Our values: IntegrityService Leadership Accountability Teamwork Passion Our purpose: protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfuturesOurvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurPurpose:Ourpurpose:protect livelihoodsandfutures.Ourvalues: IntegrityServiceLeadership AccountabilityTeamworkPassionOurpurpose:protect livelihoods and futures. Our values: IntegrityService Leadership Accountability Our purpose: protect livelihoods and futures. Our values:Integrity Service Leadership Accountability Teamwork Passion Our purpose: protect livelihoods and futures. Our values: Integrity ServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassion
Ch a r l es T. H ap p elC h i e f I nv e s t m e n t O f f i c e r
Market & Economic UpdateFBL Financial Group, Inc.IFBF Economic SummitJune 27, 2016
2
Economic Conditions & OutlookWhat’s really the problem?
Copyright 2016 Ned Davis Research
3
Economic Conditions & Outlook
How Does Growth Happen?
GDP = Labor + Productivity
4
Economic Conditions & Outlook
Change in Labor Force = Change in Working Age Population Change in Labor Force Participation Change in Hours Worked
60%
61%
62%
63%
64%
65%
66%
67%
68%
Participation Rate
0.00%
0.05%
0.10%
0.15%
0.20%
0.25%
0.30%
0.35%
0.40%
0.45%Annualized Change in Working Age Population
Source: Bloomberg
How does growth happen?
5
Economic Conditions & OutlookHow does growth happen?
Change in Productivity function of: Capital Investment
Innovation and Entrepreneurship
$44,000
$49,000
$54,000
$59,000
$64,000
$69,000
$74,000
Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 Apr-16
Capital Goods New Orders Non-Defense Ex Aircraft
Milli
ons
($)
11%
Source: Bloomberg
6
Economic Conditions & Outlook
What is holding us back?
Labor
Demographics
Immigration Policy
Taxes
Transfer Payments
Regulation– Minimum Wage– Licensing/Permitting
ACA – hire more part-time
Productivity (Cap Spending) Taxes
– Business and Personal
Regulations– 80,000 pages new and proposed in single year!– Licensing and permitting– ACA
Monetary Policy – ZIRP keeps zombies on life support
Litigation
Currency Fluctuations
Overall Policy Uncertainty
Debt
7
Economic Conditions & OutlookThe Killer D’s
Demographics, Debt, Deficits
% Change in Labor Force to 2025
Emerging Countries Developed Countries * Indonesia, Malaysia, Philippines, ThailandSource: Ned Davis Research
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
China India Mexico * MonsoonCountries
USA Europe Japan
8
Economic Conditions & OutlookWorld population growth rate 2005 - 2010.
Demographics are a headwind for our half of the world
Future global growth will be driven by MENA, Sub-Saharan Africa, India, and Mexico.
9
Economic Conditions & OutlookDebt vs GDP Growth (10-year labor force).
0%
2%
4%
6%
8%
10%
12%
14%
16%
0% 20% 40% 60% 80% 100% 120% 140% 160% 180%
Indonesia (15%)
Mexico (16%)
Germany (-4% )
China (1%)
US (6%)
Italy (1% ) Japan (-2%)
France (3% )
5yr A
nnua
lized
% N
omin
al G
DP
Private Domestic Debt as % 5yr Average GDP
India (15%)
Developed Countries
Emerging Countries
Source: Ned Davis Research
Debt is concentrated in regions with worst demographics.
10
$70
$80
$90
$100
$110
$120
$130
-0.20%
0.20%
0.60%
1.00%
1.40%
1.80%
2.20%Japan 10-year Gov’t Yield (Left)
Economic Conditions & OutlookJapan likely first to attempt monetization/helicopter money? Working-age population peaked in 1995. Growth has averaged <1% since 1990.
Japanese Yen Exchange Rate (Right)
Source: Bloomberg
The Developed Market Coal Mine Canary
—16 BP
11
Economic Conditions & OutlookGrowing at 2 percent is a home run with what we have to work with.
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
Non-Farm Productivity
US Labor Force
Growth Potential
Real GDP – 5-year Average Growth Rates
Source: Bloomberg
Current potential growth rate < 1% (prod + labor)
12
Economic Conditions & OutlookMonetary policy providing liquidity during crisis (positive) while attempting to solve structural issues with massive monetary stimulus (negative).
How are we attempting to deal with these issues? A: Buy Bonds!
Global Central Bank Balance Sheet Growth
Copyright 2016 Ned Davis Research
13
Economic Conditions & OutlookWhat is intent? Stimulate M2 growth Reduce savings in favor of spending Stimulate borrowing Asset inflation – wealth effect
– No empirical evidence to support wealth effect – only exacerbates income inequality– “The wealth effect is one of the most fraudulent concepts in economics” - Lacy Hunt
0%
100%
200%
300%
400%
500%
600%
700%
800%
900%
1000%
M2
Monetary Base
Source: Bloomberg
14
Economic Conditions & OutlookWhat is intent? Stimulate growth by incenting risk taking.
15
Economic Conditions & OutlookAny chance this could end badly?
16
Economic Conditions & OutlookFed is caught in a loop and a victim of global circumstances.
Ground Hog Day at FOMC
Fed Talks Hawkish
Market Go Risk – Off:
F Dollar RalliesF Spreads WidenF Volatility RisesF Stocks Fall
Fed Talks DovishMarket Go Risk – On:
F Dollar DeclinesF Spreads TightenF Volatility FallsF Stocks Rally
17
Economic Conditions & Outlook
Shadow chair of FOMC
Shanghai Accord?
Number of times Janet Yellen used specific words in her economic outlook speeches:
-
5
10
15
20
25
May 22, 2015 July 10, 2015 December 2, 2015 March 29, 2016
"China"
"Dollar"
"Global"
18
Economic Conditions & OutlookWill we have NIRP?
Japan: -0.29%
Germany: -0.48%
Unintended consequences – Buying safes and hoarding currency – deflationary
May actually have reduced M2 growth rates
Negative to banks, insurers, pensions, and savers
Swiss: -0.97%
France: -0.20%
United States: 1.08%
Sovereign 5-year Bond Yields (June 15, 2016)
Chris Waller, St. Louis Fed – “Negative Interest Rates: A Tax in sheep’s clothing.”Capitalism cannot function when you grossly distort the price of capital.
19
Economic Conditions & OutlookHigh, long-term correlation between nominal GDP growth and 10-yr yield. Difficult to sustain rise in rates until deleveraging cycle completed and growth rises.
Long-term proxy for 10yr = nominal GDP
10-yr BCA FV=1.53%-2.01% 1-yr forward
With exception of WWII, 30-yr yields at lowest going back to 1790
-5%
0%
5%
10%
15%
20%
GDP
10yr UST
USD GDP Nominal Dollars (YoY)
Source: Bloomberg, Ned Davis Research
Total Nonfinancial Debt as % of GDP
250% as of Q1 2016
Deleveraging?
What does this all mean for interest rates?
20
Economic Conditions & OutlookWhat does this all mean for interest rates? US consumer long-term inflation expectations breaking to new historic lows. Fed is not winning hearts and minds.
Inflation Expectations Continue to Fall
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16
Europe
Japan
Source: Bloomberg
US
21
Economic Conditions & OutlookFed Forecasts
The Fed has consistently overestimated growth and inflation
Officials had expected Funds rate to “normalize” at 4% - recently revised to close to 3% and Janet Yellen said it might be 2%
Yellen finally has acknowledged structural headwinds of demographics and production growth
Pace of any future hikes will be SLOW
22
-2%
-1%
0%
1%
2%
3%
4%
Recessionary Periods
Economic Conditions & OutlookRecession?Treasury yield curve flattening but not yet signaling recession. Is the curve distorted?
Source: Bloomberg
10-Year Yield minus 2-Year Yield
23
Economic Conditions & OutlookWhen do rates rise?
Over varying degrees of time, structural tailwinds become headwinds for bonds:
Weak cap ex and productivity growth ultimately results in supply constraints (long way to go)
Aging demographics eventually leads to reduced savings rates (Japan first) Low commodity prices move from being a detriment to a positive for growth – tax
break for the consumer (could happen very soon) Actions taken to reduce income inequality may shift money to those with higher
propensity to consume (depends on election) Populist backlash supports increased fiscal stimulus and debt monetization (next
recession?)
When rates do begin to rise meaningfully, it may happen bigger and faster than is now widely expected.
Global Bond yields likely remain low for longer period since deleveraging cycle is far from complete. Ultimate low may not occur until next recession.
24
Economic Conditions & OutlookS&P 500 vs QE. Asset prices have responded to QE. Until recently, an earnings supported market as well.
0
500
1000
1500
2000
2500
June-07 June-08 June-09 June-10 June-11 June-12 June-13 June-14 June-15 June-16
QE 1 Expanded
QE 1 Ends
QE 2 Announced
QE 2 Ends
Operation Twist Announced
QE 3 Announced
QE 3 Expanded, Operation Twist Ends
QE 3 Taper Announced
QE 3 Taper Ends Fed Rate Hike
QE 1 Announced
Source: Bloomberg
Equity Markets (S&P 500)
25
Economic Conditions & OutlookUS fund flows since recession. An unloved bull market.
Copyright 2016 Ned Davis Research
The Great Rotation?
26
Economic Conditions & OutlookValuations are not compelling, but that is true for most assets. Debt issuance supporting M&A buybacks and dividends, not cap-ex.
Copyright 2016 Ned Davis Research
S&P 500 Median Price/Earnings Ratio
27
Economic Conditions & OutlookHistoric data (Reinhart Rogoff) indicates hangover from financial crisis recession lasts 5-10 years. We are at year 8. Also wage growth we are starting to see historically is consistent with stronger GDP growth.
Source: Bloomberg
1.0%
1.5%
2.0%
2.5%
3.0%
4%
5%
6%
7%
8% Unemployment Rate (Left)
3-month Rolling Avg. Hourly Earnings YoY (Right)
Turning Point?
28
Economic Conditions & OutlookIf dollar stabilizes, commodities and emerging markets likely perform better.
$70
$75
$80
$85
$90
$95
$100
$105
$250
$300
$350
$400
$450
$500
$550
$600
Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16
US Dollar (Right)
Commodity Price Index (Left)
Source: Bloomberg
Turning Point
29
Economic Conditions & OutlookRisk factors – just as things are starting to work.
So if things are starting to work, what could go wrong?
30
Economic Conditions & Outlook
What Could Go Wrong?
Both candidates seem intent on focusing on structural economic issues
– Intent on making them worse
Political risk is severe – populist backlash untimely and dangerous
Deleveraging cycle far from complete
Millennials support bigger government – wrong answer
31
Economic Conditions & Outlook
Richard Fisher – former President of Federal Reserve – Bank of Dallas, recently spoke at investment conference in Dallas.
Question: Could you describe the position of your personal portfolio?
So What Should You Be Doing?
32
Economic Conditions & Outlook
Answer: FETAL
“All of the smart people I know are holding substantial cash.”Richard Fisher
33
Economic Conditions & Outlook
What Should You Be Doing?
True global diversification – US equities likely should not be largest allocation
Do not invest with assumption that rates rise dramatically and soon
Safety is not inherent to any asset class but is a function of valuation
Gold is not an inflation hedge but a hedge against loss of confidence in central banks
Hold cash reserve for deployment during next phase of crisis
34
Economic Conditions & Outlook
Reasons to be long-term optimists.
The degree to which the NAFTA region is outperforming the remainder of the developed world is grossly understated
Generation after the millennials will be very different
Technology/Biotechnology will solve healthcare crisis (and education) if government gets out of the way (Remember the energy crisis?)
US is still the innovation leader of the world
Structural issues are worse in other parts of the developed world – hopefully, we can learn from their failures
35
Economic Conditions & Outlook
Our purpose: protect livelihoods and futures. Our values: IntegrityService Leadership Accountability Teamwork Passion Our purpose: protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfuturesOurvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurPurpose:Ourpurpose:protect livelihoodsandfutures.Ourvalues: IntegrityServiceLeadership AccountabilityTeamworkPassionOurpurpose:protect livelihoods and futures. Our values: IntegrityService Leadership Accountability Our purpose: protect livelihoods and futures. Our values:Integrity Service Leadership Accountability Teamwork Passion Our purpose: protect livelihoods and futures. Our values: Integrity ServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassionOurpurpose:protectlivelihoodsandfutures.Ourvalues:IntegrityServiceLeadershipAccountabilityTeamworkPassion
F B L F i n a n c i a l G r o u p , I n c .F a r m B u r e a u L i f e I n s u r a n c e C o m p a n y
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