December 2014 Commentary

8/18/2019 December 2014 Commentary

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Quarterly Commentary

December 2014

333 S. Grand Ave., 18th Floor || Los Angeles, CA 90071 || (213) 633-82


2/19

Quarterly Commentary 12/31/

Overview

During the rst two weeks of December, weakness in

the Energy sector spread through global markets as

market parcipants were trying to nd an answer forthe precipitous decline in oil prices. As energy prices

connued to fall, the strength of global economic

growth came into queson. This uncertainty, coupled

with accelerated elecons in Greece and the extreme

volality in Russian nancial markets led to a decline

in most risk assets. On December 17, investor

condence received a boost following a benign

outcome from the Federal Open Market Commiee

(FOMC) which centered on new language stang thatthe FOMC will be “paent in beginning to normalize

the stance of monetary policy.” With everything

seemingly back to normal, risk assets moved higher as

if nothing ever happened.

During the second half of the month, a strong third

Gross Domesc Product (GDP) print calmed any

lingering concerns. According to the nal release of

third quarter GDP, the economy grew 5.0% quarter-

over-quarter (QoQ) marking the strongest growth in

11 years. As a result, the American consumer

appeared to be more comfortable spending as

personal consumpon contributed 2.2% to GDP.

Despite the strong gure, GDP is up 2.7% year-over-

year (YoY) outperforming most developed countries.

By comparison, 2014 GDP growth is projected to

come in below 1.0% in both the eurozone and Japan.


The European Central Bank (ECB) and the Bank of

Japan (BoJ) connued to reiterate accommodave

monetary policy in support of weaker than expectedgrowth.

Domescally, the U.S. economy appears to be on

beer foong as employment gures connued to

improve. Total nonfarm payrolls increased by 252,000

during the nal month of the year as job addions

rose unexpectedly in the construcon industry. The

increase in hiring combined with a contracon in the

civilian labor force led to the drop in the

unemployment rate which fell to a mul-year low of

5.6%.


3/19


Although the data appears strong on the surface, a

majority of job gains have gone to older cohorts. The

Energy sector has been another bright spot for

employment which may face a headwind if energy

producers connue to cut back on capital

expenditures.

Global commodity prices were the loser during

December as the energy sector led the decline.

Commodity prices as measured by the S&P GSCI Index

fell 13.63% to the lowest index level since 2009.

Lower energy prices impacted inaon data points in

the U.S. as the Consumer Price Index (CPI) and the

Producer Price Index (PPI) for nal demand fell to1.3% YoY and 1.4% YoY, respecvely. Transportaon

and raw material costs connue to decline.

Tradional markets such as U.S. equies were rather

unchanged for the month, down just 0.26%. The xed

income market as measured by the Barclays

Aggregate Bond Index rose just 0.09%. The U.S. Dollar

(USD) remained strong with the consensus viewpoint

pushing the U.S. Dollar Index (DXY) to a new 8-year

high of 90.27.



4/19


5/19



Modi has not only adjusted fuel subsidies, but lied

foreign direct investment limits, implemented small-

business labor reform, and eased investment

regulaons inland. In Indonesia, aer raising the price

of fuel, President Jokowi appointed a “working”

cabinet for his government who were relavely well-

received as market-friendly by investors. Finally in

Brazil, where third quarter GDP had a slight 10 bps

increase, investors looked favorably upon the newly

re-elected President Rousse’s appointment of the

market-friendly Joaquim Levy to the post of Finance

Minister. He has commied to targeng a 1.2%

primary scal surplus for 2015. The Brazilian

government also engaged in a number of needed

acons, including hiking the overnight lending rate

11.75% to combat inaon and changing rules to

access social benets to help reduce the scal

expenditures.

In contrast, net-exporters of energy whose budgets

were built around high oil prices have struggled in this

new environment and assets linked to them have

underperformed accordingly. Russia, Venezuela, and

Nigeria are among naons where assets have

performed poorly in the face of declining energy

prices in the fourth quarter. Russia has seen the ruble

probe lows versus the USD not seen since the global

nancial crisis in 2009, as in addion to sinking crude

oil and natural gas prices, it has had to deal with rapid

capital ight ed to sancons from the U.S. and

European Union (EU) due to its support for rebels in

Ukraine’s eastern provinces. The Russian central bank

hiked the benchmark rate to 17% in an emergency

meeng and allowed discreonary FX intervenons to

combat the tumble of the ruble in mid-December.

Though the move did appear to somewhat stabilize

the currency, the central bank’s repeated

intervenons to defend the currency have dropped

USD reserves to under $400 billion. Venezuela, which

has labored under the command of “Chavista”

economic policies of President Maduro, has seen its

sovereign debt sink to decade-lows as oil ha

retreated. The black market rate per USD reache

approximately 200 bolivares as of December 3

versus the ocial rate for 6.3 bolivares per dolla

Maduro’s government has proven unwilling t

implement any serious reforms, such as unifying o

devaluing the FX rate or reducing social transfer

Inaon stood at 63.6% as of November, while 5-yea

credit-default swaps touched all-me highs

December.

December saw a sharp reversal to the prior eigh

straight months of net inows from investors int

EMFI funds: $3.0 billion le the asset class, which waabout evenly split between hard currenc

denominated funds and local currency denominate

funds. The month’s oulows brought net fourt

quarter inows into the space down to $380 millio

For the year, EMFI funds saw $13.4 billion in inow

the bulk of which occurred in the second quarter 201

Investors’ 2014 allocaons were driven by har

currency EMFI funds which had $16.3 billion ente

versus $2.8 billion exing local currency funds in 2014


6/19


Agency Mortgage-Backed Securies

For the fourth quarter, the Barclays U.S. MBS Index

returned 1.79% while the Barclays U.S. Treasury Index

returned 1.93%. The yield curve aened further

from the previous quarter with the longer end of the

curve decreasing and the shorter end increasing. The

10-year U.S. Treasury (UST) yields declined by about

32 bps while 2-year yields increased by about 12 bps.

The underperformance is largely aributed to the

lower duraon prole of the MBS sector relave to

the UST space. The duraon of the Barclays U.S. MBS

Index shortened from 5.01 to 4.34, whereas the

Barclays U.S. Treasury Index ended the quarter at

5.58. Lower coupon MBS outperformed their higher

coupon counterparts as the lower poron of the

coupon stack usually exhibit higher duraon proles.

Not surprisingly, 30-year collateral outperformed 15-

year collateral as U.S. interest rates declined more a

the far end of the yield curve.

Prepayment speeds across all agencies (Fannie Ma

Freddie Mac, and Ginnie Mae) increased quarter-ove

-quarter (QoQ). The increases were mainly aribute

to declining rates as mortgage rates declined b

approximately 36 bps (based on Freddie Ma

Commitment Rates), allowing for more borrowers t

be incenvized to renance their mortgages. Durin

the month of October, rates were fairly volal

propagang a spike in renancing acvity (a

measured by the Mortgage Bankers Associao

(MBA) Renancing Acvity Index). Prepaymen

speeds declined MoM for the month of Novembe

but this was largely caused by the low day count o

only 18 days. Although aggregate speeds did increas

for the quarter, prepayment speeds as a whole wer

relavely stable for the most of the year. Despite 10

year UST rates declining by 86 bps for the yea

Fannie Mae prepayment speeds were fairly rang

bound between 9 and 12 CPR (Condion

Prepayment Rate). This is largely due to prepaymen

burnout having occurred for the higher porons o

the coupon stack. Much of the prepayment spee

acvity occurred within the lower 3.5s-4.5s coupon

where many of the newer originaons of loans hav

occurred (thus, having less burnout eect).



7/19


Total gross issuance of Agency MBS during the

quarter was $98 billion, $84 billion, and $59 billion for

the months of October, November, and December,

respecvely. Issuance declined QoQ caused mostly by

housing seasonality with weaker housing sales

numbers during the winter months. Issuance for the

year ended just shy of one trillion, which is about 60%

of prior year’s issuance numbers. This is consistent

with prepayment acvity being relavely stable for

the most of the year as a lack of higher prepayment

acvity normally results in lower gross issuance.

On the Government Sponsored Enterprise (GSE)

front, the recent passing of the spending bill includeda provision that prevents the Federal government

from supporng state and local eorts to use Eminent

Domain to acquire mortgages. This has helped

provide more clarity on the future of Eminent Domain

and its impact on the mortgage space going forward.

It doesn’t seem likely that further new legislaon will

made on the mortgage front with the street largely

speculang that some further extension/reform may

occur on already exisng renancing legislaon suchas HAMP (Home Aordable Modicaon Program)

and HARP 2.0 (Home Aordability Renancing

Program). While it’s sll too early to determine the

likelihood or any details of such reform, it is

important to note that programs such as HARP will be

ending by the end of 2015.



8/19


Non-Agency Mortgage-Backed Securies

The non-Agency mortgage market quietly cruised into

the end of the year on lower volume and rm pricing.

Total bid list volume accounted for $32.9 billion of

current face during the quarter with much of the

supply coming in October and November. December,

tradionally a quiet month, saw $8.9 billion of list

volume with much of the supply being evenly

distributed across collateral types. Despite weakness

on the periphery, with oil and internaonal equity

markets selling o sharply, the non-Agency market

held rm and investor appete in this sector

remained strong. There were instances of larger

block trades not trading because sellers did not

realize the prices they were hoping for, but rather

than aribute this to market weakness, this was

largely due to the fact that credit has been very

strong at the start of the new year over the past

several years and sellers are hopeful for even higher

levels in 2015.

Fundamentals have remained stable for much of the

quarter and December remiance reports have

connued this trend of stability. Credit risk transfer

trades have shown a bifurcaon on prepayment

speeds with seasoned STACR deals seeing slightly

slower prepayment speeds whereas more recent

transacons have seen increases in prepays up to 1

CPR. On the legacy bond front, the theme of stabilit

has remained. Prime collateral saw an approximat

prepay increase of 0.3 CPR while Alt-A and subprim

collateral speeds declined by 0.7 and 1.1 CP

respecvely. Liquidaon rates on prime and subprim

collateral increased by 0.8 CDR (Condional Defau

Rate) and 0.2 CDR while Alt-A liquidaons fell by 0

CDR. Modicaon rates declined on the month wit

only 0.4% of the loan populaon being modied.



9/19


Investment Grade Credit

The Investment Grade (IG) sector as measured by the

Barclays U.S. Credit Index ended the month 7 bps

wider generang a monthly total return of 0.01%. Thesector underperformed duraon-matched UST by 41

bps marking the h consecuve month of negave

excess returns. For the fourth quarter, the Index

returned 1.76% pung the sector up 7.53% for 2014.

The duraon of the Investment Grade asset class was

a big contributor during the fourth quarter as UST

rates fell.

Taking a look at December performance by sector, it

came as no surprise that commodity-related

companies underperformed. The worst-performing

sectors were Oil Field Services (-490 bps),

Independent Energy (-263 bps), Rening (-230 bps),

Metals (-164 bps) and Gaming (-160 bps). On the

opposite end of the spectrum the best performing

sectors were Health Insurance (+51 bps), Electrics

(+47 bps), Lodging (+32 bps), Airlines (+28 bps) and

Pharmaceucals (+15 bps). Performance also

diverged by credit quality as the energy and

commodity-related sell-o during resulted in a

steeper credit curve. Triple-B rated credits

underperformed on both a relave and absolute

basis, widening by 13 bps. Single-A rated credits

widened just 2 bps.

Fixed-rate gross investment grade supply fo

December was rather light at approximately $52

billion. This gure brought 2014 issuance to $1.1

trillion, a new all-me high as mergers an

acquisions (M&A) acvity remained strong. So calle

“tax-inversion” deals were the hot topic during 201

with several transacons taking place.



10/19


default rates to four-and-a-half year highs. The tw

defaults totaled $13.2 billion in bonds. The pa

weighted U.S. high-yield default rate increased t

2.96% from 1.92% in November.

High-yield new-issue acvity was light in December a

deals aimed at closing before the holidays. $7.4 billio

of USD-denominated bonds priced during the mont

making it only the second sub-$10 billion month ove

the last three years. $61.3 billion priced during th

fourth quarter.

High Yield

The High Yield sector as measured by the Ci High-Yield

Cash-Pay Capped Index lost 1.67% during the

December and 1.32% for the quarter. The Index’s yield-

to-worst was 6.67% at December 31, widening 45 bps

for the month, 56 bps for the quarter and 107 bps for

the year-to-date period. Weakness in the Energy sector

was the major concern during the rst few week of the

month as oil connued its decline. The market then

turned around by the third week as buyers stepped in

and drove some posive price momentum in the

Energy sector and high-yield overall. While yields were

higher across the rangs spectrum, investors reduced

risk in CCC-rated securies, which returned -3.16%, at a

faster pace than Bs and BBs, which returned -1.91%

and -1.06%, respecvely. Most sectors posted negave

total returns in December, with Energy-related

industries, Environmental Services and Metals/Mining

posng the weakest performance.

Technicals in High Yield deteriorated slightly during the

month as the sector experienced two defaults. The

second largest default of the year and fourth largest on

record (Caesars Entertainment Operang Co.) pushed


Source: S&P Capital IQ Leveraged Commentary and Data (LCD)


11/19


appeared to reiterate a cauous tone about raisin

rates. As such retail loan mutual funds reported the

ninth consecuve monthly oulow, which was $7billion during December and represents the large

monthly oulow for all of 2014. Net loan supp

increased by $7.9 billion during December, which wa

the second smallest monthly increase in 2014. Ne

loan supply has increased by $149.5 billion YTD

Record CLO issuance was very supporve of bank loa

issuance.

Despite the pull back during December, loan

connue to look cheaper as the fundamenta

remained relavely unchanged. There were no ne

defaults in the Index for the month of Decembe

which has resulted in the trailing 12 month defau

rate to decrease 9 bps to 3.24% (0.34% excludin

TXU).

Bank Loans

The S&P/LSTA Leveraged Loan Index lost 1.25%

during December dragging the index down 0.51%

during the fourth quarter. The index yield-to

-maturity

(YTM) increased 40 bps to 5.42% during the month of

December. The discounted spread to a 3-year life is

now LIBOR +561 bps, up 60 bps from the beginning of

the quarter.

The worst performing industry for the month was Oil

and Gas, which had a total return of –9.11% during

December. The Oil and Gas sector was also the

biggest underperformer for the quarter down 11.86%

due to the decline in the price of oil. The top

performing industry for the month of December was

Clothing-Texles, which returned -0.14%. As such, all

S&P/LSTA industries in the Index experienced a

negave total return for the month of December.

With the broader loan market on a weaker foong

during December, the average bid price decreased

1.59 points to 95.92. Demand for bank loans seemed

to wane as investors reassessed the likelihood of the

Fed raising rates. The FOMC announcement pushed

most of this fear out into the future as Janet Yellen


Source: S&P Capital IQ Leveraged Commentary and Data (LCD)


12/19


reported in December.

Industrial metals lost 5.92% as global growth slowe

considerably. Copper was down 4.64% as Chines

consumpon waned due to their economic slowdow

and inated real estate market. Aluminum fell 6.19

as demand from the aerospace and automov

sectors decreased as global growth has slowed down

Inaon connued to remain contained in the U.

while deaon is a real concern in the eurozone an

Japan leading to a drop in precious metals prices. Th

sector lost 3.07% with gold down 2.34%. Silvedisplayed its characteriscally high beta and lo

8.85%.

Commodies

In the fourth quarter, the global commodies markets

sold o 27.67% as measured by the S&P GSCI Index.

This puts the Index squarely in the red for the year,

down 33.08%. The weak fourth quarter was driven by

losses across most of the S&P GSCI sectors with only

agriculture ending up over the period. The most

acutely felt pain was in the energy sector which lost

38.90% in the fourth quarter. The best performer was

the agriculture sector; it bounced back from a weak

third quarter, ending up 8.71% for the fourth quarter.

This bear market was caused by several factors,

including an economic slowdown in China, emerging

markets and Europe, more ecient consumpon of

resources, and persistently low inaon in G7

countries.

The energy sector saw declines across the board in

the third quarter. Both Brent (-40.35%) and WTI (-

41.19%) prices collapsed as global demand waned.

The crude markets are sll tesng technical support

levels with higher volality expected over the short

term. WTI is under further pressure from increased

energy eciency in the U.S. coupled with increased

U.S. producon. Energy prices suered across the

disllate complex as well, with gas oil, heang oil and

unleaded gas all falling more than 29%. The negave

demand shock for energy products also hit natural

gas driving it down 33.60% in the fourth quarter.

Agriculture saw the greatest gain of the S&P GSCI

sectors in the fourth quarter as unfavorable weatherimpacted future yield forecasts. Wheat was the best

performer, gaining 21.82% while corn also rallied

19.70%. Sugar (-11.73%), coee (-15.81%), and cocoa

(-12.01%) were the only losers in the fourth quarter.

Livestock saw a loss of 5.00% as lean hogs (-13.94%),

live cale (-0.82%) and feeder cale (-3.21%) all lost

value. The drop in lean hogs occurred as the US pork

breeding herd recovered with larger lier sizes



13/19


and 2.0 BBs widened out 20 bps. This slight widenin

experienced this month can be largely aributed t

the glut of supply and concerns about Risk Retenon

Collateralized Loan Obligaons (CLOs)

CLO total issuance in December was roughly $7.75

billion across 16 deals, the third lightest month in

2014 following January and September. The decrease

in issuance for December can be aributed to most

market parcipants out of the oce because of the

Opal CLO conference during the rst week of

December and the holiday season at the end of the

month. December’s issuance brings the total issuance

for 2014 up to $124 billion across 234 U.S. CLO deals.

This issuance wildly outpaced market expected

issuance for 2014. Market parcipants believed

issuance for the year would be around $70-80 billion

due to the road blocks created by the Volcker Rule

and Risk Retenon. Managers increased the number

of deals they issued this year in order to print as

many deals before the implementaon of Risk

Retenon.

Regulators released the nal ruling on Risk Retenon

in December. The nal ruling pushed back the

eecve date for Risk Retenon to December 2016

back from October 2016. Manager will sll be

required to take down 5% of the CLO via a vercal or

horizontal slice. At the Opal CLO Conference this

month, Risk Retenon was the main topic of

conversaon. Managers have begun to explore the

most viable opon for taking down risk for their

respecve rms. It remains to be seen if smaller rms

will merge together or larger cash intensive rms will

buy out less cash intensive management companies.

With regards to future issuance, the general

consensus at Opal was that 2015 issuance will be in

the $60-90 billion range.

Over the month of December, spreads for 1.0 and 2.0

securies widened. 1.0 securies, CLOs created

before 2009, only widened by 5 to 10 bps for AA

through BB rated securies. AAA 1.0 spreads were

unchanged for the month. 2.0 securies also widened

with the AAA through BBB widening out by 10 bps



14/19


decreases in delinquency rates while mulfami

delinquency increased by 2 bps to 8.85% an

industrial delinquency inched up 6 bps to 7.55%

Lodging, the top performing major property type, sa

its delinquency rate fall by 20 bps to 4.77% whi

oce sector delinquency fell by 13 bps to 6.08% an

retail delinquency shrank by 1 bp to 5.66%. Th

Moody’s/RCA Commercial Property Price Indice

(CPPI) naonal major markets composite inde

increased .63% in November 2014 while non-majo

markets improved by 1.46%. Major market CPPI is u

15.4% YoY while non-major markets have improve

by 12.6%. December loan loss severies average

50% on $670 million of outstanding loans liquidated.

Commercial Mortgage-Backed Securies

CMBS markets soened in December aer an inux

of deals ooded the market in conjuncon with

broader macro market volality. Following inial

turbulence to start the month, the market took a

breather during the last two weeks as the holiday

schedule lead to limited market trading towards the

end of the year. The Barclays U.S. CMBS Index

returned -0.14% for the month and 3.86% for the

year, underperforming the broader aggregate by

35bp and 210bp respecvely. Legacy paper was at to

wider while new issue was wider throughout. For the

month, legacy AAA spreads widened by 1 bp to 88

bps over swaps. The most recently priced new issue

deal 10-year last cash ow (LCF) AAAs priced at 95

bps over swaps, a 3 bps widening over the last deal

priced in November while BBBs priced at 390 bps, a

15 bps widening.

Investors began looking towards 2015 as the holidays

approached with many pares projecng connued

growth in originaons and issuance as the CRE

markets connue to recover and more originators

enter the market. The December new issuance

calendar consisted of nine deals totaling $8 billion

brought to market. Of the nine deals, four were xed-

rate conduit transacons, totaling $5 billion of

issuance. 2014 private label CMBS issuance nished

the year at $91 billion, a 5% increase over 2013 while

2014 conduit and Single-Asset-Single-Borrower

issuance nished the year at 99 deals totaling $86

billion. Of the 99 deals, 49 were conduits totaling $57

billion in issuance, a 7% increase over 2013; and 50

were Single-Asset-Single-Borrower deals equang to

$29 billion of issuance, a 12% increase over 2013.

The overall U.S. CMBS delinquency rate decreased to

5.75% in December, down 5 bps month-over-month

and down 168 bps from December 2013, according to

Trepp Analycs. For the month, three of the ve

major property sectors (lodging, oce and retail) saw



15/19


The fourth quarter reected trends in place throug

much of 2014 and evident in December. That

falling yields on longer securies driven by lo

inaon, a strong dollar and falling foreign sovereig

debt, and rising yields on shorter maturity deb

largely driven by ancipaon of the approaching sta

of a Fed ghtening cycle. The 5-year UST yields 12 bp

in the fourth quarter, while the 10-year and 30-yea

yields fell 33 and 46 bps, respecvely. The two-ye

yield, by contrast, rose 8 bps and the one-year B

yield rose 12 bps. The Barclays U.S. Governmen

Index returned 1.86% for the quarter.

U.S. Government Securies

Market tone in December was set by a connuaon of

recent trends; weak growth and falling sovereign

yields in Europe and Japan, a strong dollar, low

inaon associated with falling commodity prices –

especially in the energy sector, and widely held view

that the Fed will begin raising yields on overnight rates

someme around mid-2015 as the domesc economy

extends its gradual recovery. The result was a mixed

performance for UST securies. Yields on balance were

slightly higher, but the year-long curve aening trend

connued unabated. The 10-year UST note yield was

virtually unchanged on the month while the 30-year

bond yield fell by 14 bps and the 5-year note yield was

up 17 bps.

The market as measured by the Barclays U.S.

Government Index returned 0.13% for the month, with

lile net capital appreciaon augmented by

Government market’s modest income, bringing theyear-to-date return to 4.92%. Treasury Inaon-

Protected Securies (TIPS) returned a dismal -1.13%,

reecng modest realized inaon and the connuing

drop in inaon expectaons. TIPS full year 2014

return fell to 3.64%. The tax-exempt market fared

beer, beneng from a comparavely long duraon,

modest supply and stable to improving credit quality.

The Barclays U.S. Municipal Bond Index returned

0.50% in December, for a stellar 2014 return of 9.05%



16/19


low oil prices and a strong dollar, but more crucial

connued weak household income growth. We ar

not convinced that lower gas prices alone ar

sucient to meaningfully improve consume

spending. Furthermore, we believe a recovery

household income is necessary before we can see

durable recovery in home construcon.

Against this backdrop, we prefer companies wit

strong revenue growth potenal, which we view a

those companies that can grow revenue despite

connued slow-growth economy. Generally speakin

these are companies that either possess the produc

service dierenaon to take market share despite

slow economy, or are compeng in secular growt

industries that are not dependent upon the aggregat

level of GDP growth. The porolio is most leverage

to secular growth companies in Technology an

Healthcare, and is underweight Energy and Ulies.

Looking back, there were some strong headwinds

2014 for acve equity management. First, 2014 wasgood year for the large-cap benchmarks and a wea

year for smaller stocks and acve equity manager

Of the 12 years Merrill Lynch has tracked the dat

2014 was the worst year for relave performance b

acve managers, with only 14% of Funds beang th

S&P 500 Index and only 6% of Growth Fund

outperforming. 2014 was a good year fo

“benchmark hugging” managers. Long term (se

research from Petajisto) high acve share has beeassociated with manager outperformance – basical

those managers who look most unlike the benchmar

are where investors found outperformance. 2014 wa

the opposite – low acve share managers signicant

outperformed high acve share managers.

Second, 2014 was most notable for the signican

outperformance by large-caps relave to small-cap

U.S. Equies

The key forces inuencing equies in the fourth

quarter were to be found outside of equies: falling

UST yields (despite impending Fed rate hikes in 2015);

a strong dollar; and the complete collapse in the price

of oil. The 10-Year UST, which started the quarter at

almost 2.5% ended December at 2.17%. Against this

backdrop, it is hardly surprising that the standout

performer in the S&P 500 Index was the Ulies

sector. For the quarter, Ulies within the S&P 500

Index were up a whopping 13%, to end up almost 29%

for the year.

The strong dollar led to the outperformance of more

domescally-focused sectors, specically Consumer

Discreonary and Staples and Healthcare. As we enter

2015, we are watching the strong dollar as one of

several challenges to revenue growth for corporate

America. Not only does the strong dollar reduce the

value of overseas earnings, but will likely depress

export-driven revenues.

Finally, the price of oil (WTI) fell 40% in the quarter,20% in December, and ended the year 47% o its highs

of the summer. Not surprisingly, the Energy sector was

the worst performing sector in the S&P 500 Index,

losing almost 11% in the fourth quarter. As we look to

2015, we see lower oil as another drag on revenue

growth. Energy exploraon and development has

represented a signicant source of capital spending in

the U.S. in recent years; with oil now trading below the

marginal cost of producon for many U.S. oil basins, itis reasonable to expect that capital spending to grind

to a halt. We were already seeing this in December

with energy companies announcing capital spending

cuts for 2015.

We believe top line growth for corporate America will

remain tough to nd in 2015, with the S&P 500 Index

struggling to deliver revenue growth above mid-single-

digits. This is due not only to the double headwind of



17/19


A reversal of this trend would most likely benet us

given our lt away from mega-caps towards midcaps.

In 2014, there was an unusually large outperformance

by defensive stocks versus cyclical stocks – the

whopping 29% return of Ulies in the S&P 500 Index

helps to show this. Even within tech stocks, we saw a

striking defensive lt in 2014 and established

technology companies generally outperformed.

As we have noted previously, the lack of

dierenaon in the market between growth and

value stocks in 2014 is notable. For the year, the

Russell 1000 Growth and Value Index returned 13.1%

and 13.5%, respecvely. This unusually strongcorrelaon was seen in the fourth quarter as well

(despite the sector-level volality), with the

benchmarks returning almost exactly the same

performance (4.8% and 5.0%, respecvely). One of the

best explanaon for this is asset ows: specically, to

the extent there were posive net ows into equies

in 2014 they went almost enrely into ETFs.



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signicantly higher +36.84%, as measured by th

Shanghai Composite. The Nikkei was +7.89%, Han

Seng +2.93%, and Kospi-5.17%. Chinese equie

beneted from targeted People’s Bank of Chin

(PBoC) easing.

Emerging markets sold o in the month of Decembe

with MSCI Emerging Markets Index -4.82%, down

4.88% in the fourth quarter. Russian equies cam

under pressure with MSCI Russia Index -23.95%

December and -33.74% during the quarter. Th

Russian economy faces headwinds from the stee

decline in oil prices and sancons imposed by th

West. Brazilian equies, as measured by the Bovesp

declined -8.62%, -7.59% for the quarter as th

country suers from lower commodity prices, hig

inaon, and twin budget and current accoun

decits.

Global Equies

Global equies as measured by the Morgan Stanley

Capital Internaonal (MSCI) All Country World Index

(ACWI) declined-2.04% in December, with fourth

quarter performance of +0.06%. U.S. equies were

generally lower during the month with the S&P 500

Index and Dow Jones Industrial Average returning -

0.42% and -0.03%, respecvely. The Nasdaq and

Russell 2000 Index were mixed returning -1.16% and

+2.68%, respecvely. Despite the weak December, U.S.

equies managed posive returns for the quarter of

with S&P 500 +4.39%, Dow Jones +4.58%, Nasdaq

+5.40%, and Russell 2000 +9.35% The macro data outof the U.S. was generally posive in December with

beer than expected jobs data, industrial producon,

consumer condence, and upward revisions to third

quarter GDP.

In Europe, regional equies came under pressure

during December with the DAX -1.76%, CAC -2.67%,

and FTSE -2.33%. In the periphery, equies declined

with the FTSEMIB -5.01% and IBEX -4.56%.1 For the

quarter, European equies were mixed with DAX

+3.50%, CAC -3.25%, and FTSE -0.86%, while in the

periphery, equies declined with the FTSEMIB -5.01%

and IBEX -4.56%. The economic data across the

Eurozone was generally disappoinng while inaon

connued to run well below the ECB’s target inaon

rate. The ECB le rates unchanged at December’s

meeng but further monetary easing is being priced in

by the market.

Asian equies were mixed for the month with the

Nikkei -0.06%, Shanghai Composite +20.37%, Hang

Seng -1.59%, and Kospi -3.29%.2 For the quarter, Asian

equies were mostly higher, with Chinese equies


1. The DAX is the German stock index, represenng 30 of the largest and most liquid German Companies that trade on the Frankfurt Exchange. The CAC 40 Index is a

French stock market index, tracking 40 of the largest French stocks on the Paris Bourse. The FTSE MIB is a benchmark stock market index for the Borsa Italiana, the Italia

naonal stock exchange, which consists of the 40 most-traded stock classes on the exchange. The IBEX is the ocial index of the Spanish Connuous Market, comprised

of the 35 most liquid stocks traded on that market.

2. The Nikkei is a price-weighted index comprised of Japan’s top 225 blue-chip companies on the Tokyo Stock Exchange. The Hang Seng is a free-oat capitalizaon-

weighted index of a selecon of companies from the Stock Exchange of Hong Kong. The Kospi is a market capitalizaon weighted index of all common stocks traded on

the Stock market Division on the Korea Stock Exchange.


19/19

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Issue selecon processes and tools illustrated throughout this presentaon are samples and may be modied periodically. Such charts are not the only tools used by t

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December 2014 Commentary