WorldwideEconomicsHCWE & Co., Cambria CA

Advancing Risky Asset Prices: the Second Phase

David Ranson, d.ranson@hcwe.com

HCWE Inc.

Prepared for the CFA Society of Texas – Austin

September 29, 2017

2 - ©2017 HCWE & Co. prod: 2Sig-4Assets

exhibit: 1

1 - © 2017 HCWE & Co. Updated January 3, 2013 prod: 2Sig-4Assets

Two Market Signals and Four Primary Asset Classes

PHYSICAL &FOREIGNASSETS

DOMESTICSTOCKS

DOMESTICBONDS

GOLD

market signalsof economic anxiety

and currency instability

increasing anxietystrengthening currency

increasing anxietyweakening currency

diminishing anxietystrengthening currency

diminishing anxietyweakening currency

3 - ©2017 HCWE & Co. prod: ClassifyEconScenarios/ClassifyAssetScenarios

exhibit: 2

source: ClassifyEconScenarios-112415

Four Primary Economic Scenarios

deflationaryslowdown

deflationaryexpansion

inflationaryslowdown

inflationaryexpansion

inflationdecelerating

growthdecelerating

growthaccelerating

inflationaccelerating

Updated March 29, 2016© 2014 H.C. Wainwright & Co. Economics Inc.

1 - © 2017 HCWE & Co. Updated January 3, 2013 prod: ClassifyAssetScenarios

Using Scenarios to Classify Assets

inflationdecelerating

growthdecelerating

growthaccelerating

inflationaccelerating

haven assets

risky assets

“soft”assets

vulnerableto

inflation

“hard”assets

boostedby

inflation

4 - ©2017 HCWE & Co. prod: AssetClass

exhibit: 3

1Updated July 21, 2015

© 2015 HCWE Inc. prod: SpecExh/AssetClass

Treasury bondsMBS

high-grade bondsgold

US equities

non-precious commoditiesadjustable rate debtforeign currenciesemerging equities

REITs

commercialreal estate

C-grade bonds

B-grade bondsMLPsEAFE

Baa-Aaa spreadhas widened

Baa-Aaa spreadhas narrowed

NEUTRAL

gold pricehas risen

gold pricehas fallen

NW

SW SE

EW

S

N

NE

NORTH: heightened business risk

EAST:currency

weakeningor

instability

An Asset-Allocation “Compass”

5 - ©2017 HCWE & Co. prod: RiskHardResponse.ai prog: 14 FMTAA TURN

exhibit: 4

Response of Risky-Hard Assets to Market Signals from Credit Spreads and Goldcalendar-year average dats from 1987

Data: monthly returns from high-yield bonds (Bank of America Merrill Lynch), US all-equity REITs (FTSE NAREIT) and unweighted indices of commod-ity groups (Thomson Reuters Commodity Research Bureau) and emerging equity markets (Morgan Stanley Capital International).

s4

s3

s2

s1

emerging marketsequity REITscommoditieshigh-yield bonds

following-year performance of:

0

5

10

15

20

25

30PERCENT

24.4

14.7

10.2 10.0

15.7

12.2

2.1

10.0 9.9

5.3

2.8

0.2

spreads weredown and

gold was up(7 years)

gold and spreadshad moved in the

same direction(18 years)

spreads wereup and goldwas down(4 years)

AVERAGESfor yearsin which:

6 - ©2017 HCWE & Co. prod: DoubleTurn-Sig prog: 7 HIGHYIELD PARADIGM

exhibit: 5

1 - © 2017 HCWE & Co. Updated November 8, 2017 prod: DoubleTurn-Sig prog: 7 HIYIELD PARADIGM

A Rare Double Turning Point in Market Signals from Spreads and Goldmonth-average data from the beginning of 2015

Data: Month-average yields on Baa and Aaa corporate bonds (Moody’s/Federal Reserve Board) and month-average spot prices for gold (Metals Week).

0

10

20

30

40

50

0

10

20

30

40

50

left

2017I

2016I

2015I

PERCENT PERCENT

MONTH AVERAGE

Baa-Aaa yield ratio price of gold

percentage by whichthe Baa yield exceedsthe Aaa yield (left scale)

percentage by whichgold exceeds price

end of 2015(right scale)

7774

696769 68 67 72

69

69

70

99

9091

96

94

105

115

127

140

149

139

95 90

145

138131

117

103

103 9492

9087

85

basis point spread

7 - ©2017 HCWE & Co. prod: CommodPriceTurn prog: 14FMTAA TURNING-f1

exhibit: 6

1 - © 2017 HCWE & Co. Updated November 8, 2017 prod: CommodPriceTurn prog: 14 FMTAA TURNING-f1

The Turnaround in Commodity Pricesmonth-end price data from the beginning of 2015

Data: Reuters Bridge Commodity Research Bureau.

Textiles

Industrial metals

Foodstuffs

Crude oil

Raw industrial materials

2017I

2016I

2015I80

90

100

110

120

130

140

150

160

170INDEX end of 2015 = 100

MONTHS

industrialmetals

raw industrialmaterials

foodstuffs

crude oil

textiles

8 - ©2017 HCWE & Co. prod: EmergReAwaken prog: 13 Webcast WC0916-e7

exhibit: 7

1 - © 2017 HCWE & Co. Updated November 8, 2017 prod: EmergReAwaken prog: 13 WEBCAST WC0916-e7

The Outlook for the Emerging World Re-Awakensmonth-end data from the end of 2014

Data: Monthly total returns from emerging markets (Morgan Stanley Capital International/HCWE & Co.).

s4

s3

s2

s1

2017I

2016I

2015I80

90

100

110

120

130

160

150

140

INDEX (End of 2015 = 100)

MONTH END

emerging marketsequal-weighted

emerging marketsvalue-weighted

Chinafrontiermarkets

9 - ©2017 HCWE & Co. prod: HighYield-Turn prog: 7 HIYIELD TAROUND

exhibit: 8

1 - © 2017 HCWE & Co. Updated November 9, 2017 prod: HighYield-Turn prog: 7 HIYIELD TAROUND

The Turnaround in the High-Yield Marketmonth-end data from the beginning of 2015

Data: Month-end yields for Baa and Aaa corporate bonds (Moody’s/Federal Reserve Board) and total-return indices for BB-grade, B-grade and C-grade corporate bonds (Bank of America Merrill Lynch) and SPUSDHYT, an index of distressed corporate debt (Standard & Poor’s).

distressed

C-grade

B-grade

BB-grade

2017I

2016I

2015I90

100

110

120

130

140

150

190

180

170

160

INDEX (End of 2015 = 100)

MONTH END

BB-grade

B-grade

C-grade

distressed

10 - ©2017 HCWE & Co. prod: ReitsAwaken prog: 6GREITS GREITS

exhibit: 9

1 - © 2017 HCWE & Co. Updated November 10, 2017 prod: ReitsAwaken prog: 6 GREITS GREITS

The Roller-Coaster Advance in Equity REITsmonthly data since the beginning of 2015

Data: Month-end total-return indices of US and international real estate investment trusts (National Association of Real Estate Investment Trusts/FTSE/Bloomberg).

s4

s3

s2

s1

2017I

2016I

2015I90

95

100

105

110

115

120INDEX End of 2015 = 100

MONTH END

US REITsdeveloped

world ex US

developedworld

Asia

11 - ©2017 HCWE & Co. prod: StocksHardRisky prog: N/A

exhibit: 10

1 - © 2017 HCWE & Co. Updated November 8, 2017 prod: StocksHardRisky prog: N/A

Data: Month-end total-return indices for the S&P 500 (University of Chicago/Dimensional Fund Advisors), the EAFE index (Morgan Stanley Capital International) and an equal mix of four hard-risky assets: emerging-market equities (MSCI), diversified spot commodities (Thomson Reuters Commodity Research Bireau/HCWE & Co.), and US equity REITs (National Association of Real Estate Investment Trusts). The commodity index gives equal weight to crude oil, industial metals, foodstuffs and textiles and is rebalanced monthly.

hard-risky

ROW

S&P

2017I

2016I

2015I85

90

95

100

105

110

115

120

125

130

135INDEX (End of 2015 = 100)

MONTH END

hard-risky

S&P

ROW

The Comparative Performance of Stocks and Hard-Risky Assetsmonth-end total-return data from the beginning of 2015

12 - ©2017 HCWE & Co. prod: GoldHardRisky prog: 14 FMTAA TURN

exhibit: 11

1 - © 2017 HCWE & Co. Updated November 8, 2017 prod: GoldHardRisky prog: 14 FMTAA TURN

How Gold Led the Turnaround in Hard-Risky Assetsmonth-end price data from the beginning of 2015

Data: Month-end total-return indices for spot gold (Metals Week), C-grade high-yield bonds (Bank of America Merrill Lynch), US equity REITs (National Association of Real Estate Investment Trusts), emerging market equities (Morgan Stanley Capital International), and diversified spot commodities (Thom-son Reuters Commodity Research Bureau/HCWE & Co.). The commodity index gives equal weight to crude oil, industrial metals, foodstuffs, and textiles, and is rebalanced monthly.

hard-risky assets

gold

2017I

2016I

2015I90

100

110

120

140

130

INDEX (End of 2015 = 100)

MONTH END

gold hard-risky assets

13 - ©2017 HCWE & Co. prod: PlungReversAdvancPersist prog: N/Ace

exhibit: 12

1 - © 2017 HCWE & Co. Updated November 20, 2017 prod: PlungRevers-AdvancPersist prog: N/A

Data: Year-end prices for US large-cap stocks (1814-1925 Ibbotson Associates/Morningstar; and 1925-2008 University of Chicago/Dimensional Fund Advisors).

Stock-market Plunges Tend to Reverse, but Advances Tend to Persistmonthly price changes since 1949

-10

0

10

20

30

0 1 2 4 6 8 10 12 14 16 18

median cumulative price change following months that the market:

PERCENT

MONTHS

rose less than 5%

fell more than 5%

fell less than 5%

rose more than 5%

14 - ©2017 HCWE & Co. prod: StockPriceChanges prog: N/A

exhibit: 13

1 - © 2017 HCWE & Co. Updated November 20, 2017 prod: StockPriceChanges prog: N/A

Data: Year-end prices for US large-cap stocks (1814-1925, Ibbotson Associates/Morning Star; 1925-2008, University of Chicago/Dimensional Fund Advisors).

Persistence and Reversal in Annual Changes in US Stock Pricesfrom 1814

0

2

4

6

8

10

12

14

16

18

series 1

fellmore than25% pts.

relative tothe mean

fellbetween

5 and25% pts.

relative tothe mean

changedless than5% pts.

relative tothe mean

rosebetween

5 and25% pts.

relative tothe mean

rosemore than25% pts.

relative tothe mean

PERCENT

3.6

0.7

4.9

10.3

15.1

AVERAGESfor yearsin which

stocks prices:

(16 yearsaveraging

39%)(62 yearsaveraging

17%)

(50 yearsaveraging

3%)(54 yearsaveraging

-11%)

(11 yearsaveraging

-29%)

following-year stock-marketprice change

HCWE15 - ©2017 HCWE & Co.

What Are We to Conclude?

• Commodities and many other risky asset classes are often volatile, but they have a marked tendency to climb or to drop back together

• Domestic equities fall into a separate, “soft,” category of risky assets – favored by a dollar that is strong/stable rather than weak/unstable

• The contrast between a rising and declining hard-risky market could hardly be more dramatic than the experience of the past two or three years

• Assets in this category include energy and non-energy commodities, emerging equity markets, high-yield and floating rate bonds, and real-estate investment trusts

• All of these assets bottomed simultaneously in February of 2016

• Month to month, a simple mix of these would have scarcely missed a beat as they advanced from the bottom to produce a cumulative return of 40 percent

• At any given time, a stock-market advance is much likely to persist rather than be reversed

• Contrary to popular wisdom, the residual life expectancy of a bull market does not decline with age

• The second phase of the risky-hard asset advance is likely to be slower and could be more volatile

• It will continue to be pockmarked by temporary cross currents such as this year’s drop in the energy sector

P . O . B o x 1 1 0 8 · C a m b r i a , C A 9 3 4 2 8 · U S A

P h o n e + 1 ( 9 7 8 ) 4 6 8 - 4 5 75 · w w w . h c w e . c o m

WorldwideEconomicsHCWE & Co., Cambria CA

16 - ©2017 HCWE & Co.

©2017 HCWE & Co. All rights reserved. No portion of this report may be reproduced in any form without prior written consent. The information has been compiled from sources we believe to be reliable, but we do not hold ourselves responsible for its correctness.

Opinions are presented without guarantee.