Happy New Year? Chief Investment StrategistClient minimum: $10 million Average client size: $22 million* Locations: New York, Boston, Charlotte, Chicago, Philadelphia, Wilmington *As

©2015 Brown Brothers Harriman & Co. Confidential & Proprietary. Not to be reproduced without the explicit consent of BBH & C5. “BBH” and “BBH & Co.” are registered service marks of Brown Brothers Harriman & Co.

Happy New Year? The Economy and Markets in 2015

20 March 2015

G. Scott Clemons, CFA Chief Investment Strategist 140 Broadway New York, NY 10005 [email protected]

@GSClemons

©2015 Brown Brothers Harriman & Co. Confidential & Proprietary. Not to be reproduced without the explicit consent of BBH & Co. "BBH" and "BBH & Co." are registered service marks of Brown Brothers Harriman & Co.

Brown Brothers Harriman Snapshot

2

BBH is a global financial institution with over 5,000 employees in 17 offices worldwide and expertise in Private

Banking, Investment Management, and Investor Services. Our Private Banking business serves both corporate

and private clients throughout the cycle of wealth creation, transition and preservation in five primary products:

Investment Advisory, Corporate Lending, Corporate Advisory, Private Equity, and Trust.

About Investment Advisory & Trust

Assets under management: $27.1 billion*

Clients we serve:

• Private business owners • Business executives • Inheritors of family wealth • Endowments • Foundations

Client minimum: $10 million

Average client size: $22 million*

Locations: New York, Boston, Charlotte, Chicago, Philadelphia, Wilmington

*As of December 31, 2014


Roadmap of the Domestic Economy

3

Housing Market

Labor Market

Personal Consumption GDP

Wealth Effect

Income Effect

Deleveraging Savings


The Housing Market Home Prices Rising at a 5% Annualized Pace…

4

- 20%

- 15%

- 10 %

- 5%

0%

5%

10%

15 %

20 %

$ -

$50

$100

$150

$200

$250

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: National Association of Realtors, BBH Analysis

Median Home Price (left hand scale)

Year-over-Year Change (right hand scale)


The Housing Market … and Sales and Starts Continue to Improve as Well

5

0

1

2

3

4

5

6

7

8

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Millions of Units

Sources: U.S. Department of Commerce, National Association of Realtors

New Housing Starts (+127% from trough)

Existing Home Sales (+50% from trough)


The Labor Market 3.2 million jobs added in the last year … bringing unemployment down to 5.5%

6

- 1%

1%

3%

5 %

7 %

9%

11%

- 1,000

- 800

- 600

- 400

- 200

0

200

400

600

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

000 s

Source: Bureau of Labor Statistics, BBH Analysis

Monthly Net Job Gains

Unemployment Rate


The Labor Market … and Initial Claims Augur for Further Improvement

7

-

100

200

300

400

500

600

700

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

000 s

Source: Department of Labor, BBH Analysis


The Conundrum of Wages

8

- 3%

- 2%

- 1%

0%

1%

2%

3%

4 %

5%

6%

2001 2003 2005 2007 2009 2011 2013 2015

Real Wage Growth Year Over Year

Nominal Wage Growth Year Over Year

2.1% 2.0%


Average Weekly Hours Worked

9

32 . 70

32 . 90

33 . 10

33 . 30

33 . 50

33 . 70

33 . 90

34 . 10

34 . 30

34.50

2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: Bureau of Labor Statistics

Hours Worked per Week

Hours Worked per Week


Household Debt American Households Have Deleveraged Since the Financial Crisis …

10

60 %

70 %

80 %

90%

100 %

110%

120 %

130 %

140 %

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Source: Federal Reserve, BBH Analysis

Household Debt as a % of Disposable Income

129.7%

102.7%


Households Savings … and Increased their Savings Rates

11

0 %

2 %

4 %

6 %

8 %

10 %

12 %

14 %

16 %

18 %

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Sources: Bureau of Economic Analysis, BBH Analysis

Trailing One Year Average

Savings as % of Disposable Income

Is a drop in the savings rate supporting personal consumption?


Gross Domestic Product (GDP) Growth

12

- 10 %

- 8 %

- 6 %

- 4 %

- 2 %

0 %

2 %

4 %

6 %

8 %

10 %

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

S ource: Bureau of Economic Analysis, BBH Analysis

2.3% recovery average


Gross Domestic Product Contributions to GDP Growth

13

- 2 %

- 1 %

0 %

1 %

2 %

3 %

4 %

2012 - I 2012 - II 2012 - III 2012 - IV 2013 - I 2013 - II 2013 - III 2013 - IV 2014 - I 2014 - II 2014 - III 2014 - IV

Personal Consumption

Business Spending

Net Exports

Government Spending

Source: Bureau of Economic Analysis, BBH Analysis


Roadmap of the Domestic Economy

14

Housing Market

Labor Market

Personal Consumption GDP

Wealth Effect

Income Effect

Deleveraging Savings


The Economy in 2015

15

• What are the implications of lower energy prices for economic activity?

• How might economic activity abroad effect the United States?

• What is the likely timing of an increase in interest rates, and what are the implications of that shift for the economy and markets?


Sharp Decline in Oil Prices

16

West Texas Intermediate Crude Oil $/bbl

0

20

40

60

80

100

120

140

160

2007 2008 2009 2010 2011 2012 2013 2014 2015

OPEC cuts production by 15%, oil bottoms 3 days later.

OPEC maintains production target of 30 million boe per day.


Regional Production Trends

17

-

2 , 000

4 , 000

6 , 000

8 , 000

10 , 000

12 , 000

14 , 000

1983 1988 1993 1998 2003 2008 2013

Crude Oil Production by Region (thousands of barrels per day)

Sources: U.S. Energy Information Administration, BBH Analysis

United States

Saudi Arabia

10 Year CAGR 3.5%

10 Year CAGR 1.0%


Declining Energy Prices Boost Spending Power Economic Implications of $50 Oil

18

Economic Implication $ Impact* % of GDP*

Consumer savings from lower gasoline prices …

$65 billion 0.4%

Plus business savings from lower energy prices …

$300 billion + 1.7%

Minus cost to domestic energy producers $170 billion - 1.0%

Equals net economic benefit $195 billion = 1.1%

* annualized Rule of thumb: $10 change in the price of oil equates to an annualized economic impact of ~0.2% of GDP.


Europe Failure to Achieve Economic Escape Velocity

19

- 12 %

- 10 %

- 8 %

- 6 %

- 4 %

- 2 %

0 %

2 %

4 %

6 %

2006 2007 2008 2009 2010 2011 2012 2013 2014

S ource: Eurostat, BBH Analysis

Eurozone Quarterly Real GDP Growth Annualized


- 6 %

- 4 %

- 2 %

0 %

2 %

4 %

6 %

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

S ource: OECD, BBH Analysis

Europe Leading Economic Indicators Headed Down

20

Year Over Year Change in LEI Index Recessions

?


Japan Missing the Third Arrow

21

- 20 %

- 15 %

- 10 %

- 5 %

0 %

5 %

10 %

15 %

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

Japan Quarterly Real GDP Growth Annualized

1.5%


Japan Leading Economic Indicators in Negative Territory

22

- 30 %

- 20 %

- 10 %

0 %

10 %

20 %

30 %

40 %

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

Year Over Year Change in LEI Index

?


China Cause for Concern?

23

0 %

2 %

4 %

6 %

8 %

10 %

12 %

14 %

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

7.3%

China Quarterly Real GDP Growth Annualized

Sources: National Bureau of Statistics China, BBH Analysis


China Alternative Measures of Economic Activity

24


China Alternative Measures of Economic Activity

25


Monetary Policy The Beginning of the End of Easy Money …

26

• Although quantitative easing has ended, and the Fed has stopped its additional purchases of bonds, monetary policy remains very accommodative.


Balance Sheet of the Federal Reserve

27

$ -

$ 500

$ 1 , 000

$ 1 , 500

$ 2 , 000

$ 2 , 500

$ 3 , 000

$ 3 , 500

$ 4 , 000

$ 4 , 500

$ 5 , 000

2007 2008 2009 2010 2011 2012 2013 2014

$ Billions

Source: Federal Reserve, BBH Analysis

QE 1 QE 2 QE 3

Assets on the Balance Sheet of the Federal Reserve



28


• The decision to begin raising interest rates to more normal levels is a function of the strength of the economy and the threat of inflation.


Inflation … Or the Lack Thereof

29

0 . 0 %

0 . 5 %

1 . 0 %

1 . 5 %

2 . 0 %

2 . 5 %

3.0%

3 . 5 %

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: Bureau of Labor Statistics, BBH Analysis

% Change Year - over - Year

Core PCE

CPI Inflation ex Food and Energy

1.6%

1.3%


Inflation Expectations of Disinflation

30

- 0 . 5 %

0 . 0 %

0 . 5 %

1 . 0 %

1.5%

2 . 0 %

2.5%

3 . 0 %

3 . 5 %

2008 2009 2010 2011 2012 2013 2014 2015

Sources: Bloomberg, BBH Analysis

5 Year-5 Year Forward

10 Year Breakeven Spread



31


• The decision to begin raising interest rates to more normal levels is a function of the strength of the economy and the threat of inflation.

• With inflation no real and present danger, the Fed can afford to be patient in raising interest rates.


Monetary Policy Interest Rates Expected to Normalize at a Slow Pace

32


Monetary Policy Longer Rates Down as Inflation Fears Wane

33

%

%

0 . 01 0 . 01 % 0 . 09 %

0 . 70 %

1 . 66 % 2 . 20

2 . 81 %

%

0 . 05 % 0 . 05 % 0 . 08 %

0 . 37 %

1 . 64

2 . 79 %

3 . 72 %

- 1 %

0 %

1 %

2 %

3 %

4 %

5 %

1 Month 3 Month 6 Month 2 Year 5 Year 10 Year 30 Year

Source: Bloomberg, BBH Analysis

7 March 2014

9 March 2015


Equity Markets The S&P 500 Has Tripled From the Trough of the Crisis …

34

600

800

1 , 000

1 , 200

1 , 400

1 , 600

1 , 800

2 , 000

2 , 200

2008 2009 2010 2011 2012 2013 2014 2015

Source: Bloomberg, BBH Analysis


Corporate Earnings Growth

35

- 60 %

- 40 %

- 20 %

0 %

20 %

40 %

60 %

80 %

100 %

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: Standard and Poor's, BBH Analysis

% Change Year - over - Year

2015 consensus

4Q2014 Earnings


Operating Profit Margins

36


Market Valuations

37

25.4x

0

5

10

15

20

25

30

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Sources: Standard and Poor's, Robert Shiller, BBH Analysis

+ 2 standard deviations

+ 1 standard deviation

- 2 standard deviations

- 1 standard deviation

Average

20.4x

18.6x

15.4x

10.4x

5.4x

S&P 500 Trailing PE Ratio


The Market Formula in 2014

38

Price = Earnings x P E

The S&P 500 Index rose 11.4% in 2014 (13.7% including dividends).

S&P 500 earnings were up 5% year over year …

… so higher valuations accounted for about half the market move.


Market Conclusions

39

• It’s all about the earnings …

• The option value of cash remains appealing, as it provides the opportunity to take advantage of market corrections to redeploy cash into more

productive assets.

• … and the earnings are all about the revenues. With profit margins at such high levels, earnings growth from continued cost cutting or margin

expansion will be hard to come by.

• As interest rates rise, we will at some point put assets back to work in more traditional fixed income, but only when we believe that investors are being

adequately compensated for inflation and price risk.


Economic Conclusions

40

• Sustained gains in the housing and labor markets bode well for continued improvement in the U.S. economy.

• In order to support this moderate expansion, and in the absence of inflationary pressures, the Federal Reserve is likely to take its time in

restoring more normal monetary policy.

• Focus on the health of Personal Consumption: as goes the consumer, so goes the economy.

• The fall in energy prices, if sustained, could have a meaningful effect on economic growth in 2015, increasing GDP growth by a full percentage point.

©2015 Brown Brothers Harriman & Co. Confidential & Proprietary. Not to be reproduced without the explicit consent of BBH & C5. “BBH” and “BBH & Co.” are registered service marks of Brown Brothers Harriman & Co.

Happy New Year? The Economy and Markets in 2015

20 March 2015

G. Scott Clemons, CFA Chief Investment Strategist 140 Broadway New York, NY 10005 [email protected]

@GSClemons

Documents

Happy New Year? Chief Investment StrategistClient minimum: $10 million Average client size: $22 million* Locations: New York, Boston, Charlotte, Chicago, Philadelphia, Wilmington *As