September Investment Strategy Outlook

Please refer to Appendix – Important Disclosures.

Weight of the Evidence Argues for Caution

Highlights: • Stocks Move Into Correction Phase – First Since 2011 • Valuations Start to Improve • Investor Skepticism on the Rise • Breadth Has Broken Down

Breadth turned bearish in August, and with it the overall weight of the

evidence moved from neutral to arguing for more caution. This came as

the trading range environment seen earlier in the year morphed into

the first 10% correction experienced by the S&P 500 since 2011. While

the proximate cause of the sell-off was a China-related challenge to central

bank credibility, deteriorating breadth, excessively high valuations, and generally poor investor liquidity were all contributing factors.

Even as the popular averages established narrow trading ranges in the first seven months of 2015, rally participation within the

indexes was faltering. As the selling unfolded in August, downside momentum built up and we finally saw some evidence of fear

and panic from investors. A panic low was established and downside momentum appeared to be halted as the

support/resistance parameters for a consolidation phase came into focus.

At this point, cycle lows for the

popular averages may well be in

place. This is not yet supported by

the weight of the evidence, however.

Simply put, risks remain elevated

and it is too early to sound an all

clear. We have seen some evidence

of fear and panic, but investors

remain plagued by poor liquidity.

History suggests that a re-test of

August lows prior to substantially

higher highs is more likely than not.

The good news is that such a re-test

could provide a chance for bullish

breadth divergences to emerge.

Improving seasonal patterns and the

prospect of better clarity from the Fed

could provide tailwinds for stocks in

the year’s final quarter.

Investment Strategy Outlook September 1, 2015

Baird Market & Investment Strategy

Outlook Summary

Caution for Now, but Conditions Could

Improve in Q4

History Suggests Consolidation Followed by Re-Test of Lows

Fed Credibility Coming Into Focus As

Potential Lift-Off Date Approaches

Economic Trends Continue Slow Improvement

Bruce Bittles Chief Investment Strategist [email protected] 941-906-2830

William Delwiche, CMT, CFAInvestment Strategist [email protected] 414-298-7802

Indicator Review

10R.17

After moving within a historically tight

range for over nine months, the

pressure from downward momentum

and deteriorating breadth proved

overwhelming. Support on the S&P 500

near 2040 gave way and the first 10%

correction since 2011 quickly emerged.

After an initial bounce off the lows,

history suggests a consolidation phase

and re-test of the lows is most likely.

This would be constructive if it helps

keep skepticism high and allows for the

emergence of bullish breadth

divergences.

Federal Reserve Policy is neutral.

Following a botched response to stock

market volatility by the Chinese central

bank, the Fed’s own credibility is the

focus of attention. Uncertainty over the

Fed’s rate hike plans is a headwind for

stocks, and the overall monetary, fiscal

and exchange rate policy environment

has already gotten tighter (as can be

seen in this chart). In other words if

the Fed backs away from beginning

to normalize interest rates in

September, it will send a mixed

message and risk undermining its

credibility with the markets. The

better course (and more bullish

outcome in our view) would be to

endorse its past plans and the strength

of the economy and begin the slow

path to normalization sooner rather

than later.

Source: Ned Davis Research

Source: StockCharts

Investment Strategy Outlook

Robert W. Baird & Co. Page 3 of 8

Economic Fundamentals remain

bullish. Individual data releases often

get overanalyzed and overreacted to.

Too often we focus exclusively on the

trees and cannot see the forest. When

the Fed describes itself as data

dependent that does not mean it treats

all data the same – it is not looking at a

sequence of trees. The hope and

expectation is that it sees the forest as

whole. Stepping back from the monthly

flow of data, we can see a trend

emerging for the economy. The bottom

clip in this chart shows that after more

than a decade the economy is finally

able to grow modestly above potential.

This reflects healing in the economy,

is bullish for stocks, and supports

near-term action by the Fed.

Valuations remain bearish. Stock

market valuations remain elevated,

although the August decline in stocks

has relieved some of the pressure.

Further consolidation from a price

perspective and/or improved earnings

growth (seemingly the more

challenging of the two) could provide

further relief. We do not need to see

historically undervalued levels to

get more constructive on

valuations, but moving further from

overvalued territory would be

helpful.





Investor Sentiment is neutral. We

continue to rate sentiment as neutral,

but are encouraged by the increase in

skepticism we have seen in recent

weeks and months. The latest reading

from Investors Intelligence shows the

fewest bulls since 2010 and a continued

contraction in the spread between bulls

and bears. Bears, however, remain at

relatively low levels. A further rise in

pessimism (similar to what was seen

in 2011) and a buildup in investor

liquidity could provide evidence that

the crowd has turned sufficiently

bearish that it is time to tilt in the

other direction.

We did finally see some evidence of

fear and panic on the part of investors.

During the August swoon, the VIX

index broke out to levels not seen

since 2010 and 2011. The concern

from our perspective is that

skepticism will be short-lived and

investors will immediately turn more

hopeful (and less fearful) as stocks

stabilize. Fund flow data show this

may be happening, as equity inflows

surged in late August. A more

constructive outcome would be a

consolidation in stocks that allows

investor concerns to remain elevated,

as this could help build the basis of a

sustainable low from which the next

cyclical rally could emerge.

Source: StockCharts



Seasonal patterns are neutral.

September has a well-deserved history

of being a tough month for stocks, but

the severity of the August decline could

take some of this sting away. Either

way, the fourth quarter typically belongs

to the bulls, and the re-emergence of

seasonal tailwinds in the fourth quarter

could help turn the weight of the

evidence in a more bullish direction.

Breadth has turned bearish. While

the percent of industry groups in up-

trends bounced off of the October

lows, the improvement fell short of

making a higher high. 2015 has been

marked by a steady deterioration in

rally participation, a trend that

accelerated to the downside over the

course of the summer. Now, just 38%

of groups are in up-trends, the smallest

percentage since 2011. To gain

confidence that the correction has

run its course, we need to see

sustained improvement in this

indicator.

0

200

400

600

800

1000

1200

1400

1600

1800

2000

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

03 04 05 06 07 08 09 10 11 12 13 14 15

S&P 500 and Industry Group Breadth

Industry Group Up‐Trend %

S&P 500 (right)

Source: FactSet, RWB Calculations




We can see a similar deterioration in

breadth when looking at the number of

S&P 500 stocks trading above their 50-

day averages (the second clip in the

chart to the right) or the expansion in the

number of new lows (bottom clip). The

late August panic lows may well mark

extreme readings in these indicators.

The opportunity for bullish breadth

divergences would come if the S&P

500 re-tests its lows, but these make

a series of higher lows. If that

emerges, the case for a year-end rally

would be enhanced.

Sector-level leadership on a year-to-

date basis remains with Consumer

Discretionary and Health Care (the

only two sectors, as of this writing, that

are still in positive territory for 2015).

Within our relative strength

rankings, we have seen some

deterioration out of the Health Care

sector (cooling trends in Biotech

could be a headwind). Now, the

consumer sectors (Discretionary and

Staples) have moved into relative

leadership positions.

Volatility in Materials and Energy has

increased, but we would continue to

steer clear of those areas. There is

little evidence that sustainable positive

trends are emerging in those sectors.

Source: Baird

Source: Stock Charts



BAIRD STRATEGIC ASSET ALLOCATION MODEL PORTFOLIOS

Baird offers six strategic asset allocation model portfolios for consideration (see table below), four of which have a mix of equity and fixed income. An individual’s personal situation, preferences and objectives may suggest an allocation more suitable than those shown below. Please consult a Baird Financial Advisor in determining an asset allocation that will meet your needs.

Model Portfolio Mix: Stocks /

(Bonds + Cash) Risk Tolerance Strategic Asset Allocation Model Summary

All Growth 100 / 0 Well above averageEmphasis on providing aggressive growth of capital with high fluctuations in the annual returns and overall market value of the portfolio.

Capital Growth 80 / 20 Above average Emphasis on providing growth of capital with moderately high fluctuations in the annual returns and overall market value of the portfolio.

Growth with Income

60 / 40 Average Emphasis on providing moderate growth of capital and some current income with moderate fluctuations in annual returns and overall market value of the portfolio.

Income with Growth

40 / 60 Below average Emphasis on providing high current income and some growth of capital with moderate fluctuations in the annual returns and overall market value of the portfolio.

Conservative Income

20 / 80 Well below averageEmphasis on providing high current income with relatively small fluctuations in the annual returns and overall market value of the portfolio.

Capital Preservation

0 / 100 Well below averageEmphasis on preserving capital while generating current income with relatively small fluctuations in the annual returns and overall market value of the portfolio.

Baird’s Investment Policy Committee offers a view of potential tactical allocations amongst equity, fixed income and cash, based upon a consideration of U.S. Federal Reserve policy, underlying U.S. economic fundamentals, investor sentiment, valuations, seasonal trends, and broad market trends. As conditions change, the Investment Policy Committee adjusts the weightings. The table below shows both the normal range and current recommended allocation to stocks, bonds and cash. Please consult a Baird Financial Advisor in determining if an adjustment to your strategic asset allocation is appropriate in your situation.

Asset Class / Model Portfolio

All Growth Capital GrowthGrowth with

Income Income with

Growth Conservative

Income Capital

Preservation

Equities:

Suggested allocation 95% 75% 55% 35% 15% 0%

Normal range 90 – 100% 70 - 90% 50 - 70% 30 - 50% 10 - 30% 0%

Fixed Income:


Normal range 0 - 0% 10 - 30% 30 - 50% 40 - 60% 45 - 65% 55 – 85%

Cash:


Normal range 0 - 10% 0 - 20% 0 - 20% 10 - 30% 25 - 45% 15 - 45%



ROBERT W. BAIRD’S INVESTMENT POLICY COMMITTEE

Bruce A. Bittles B. Craig Elder Jay E. Schwister, CFAManaging Director Director Managing Director Chief Investment Strategist PWM – Fixed Income Analyst Baird Advisors, Sr. PM

Kathy Blake Carey, CFA Jon A. Langenfeld, CFA Timothy M. Steffen, CPA, CFP®

Director Managing Director Director Associate Director of PWM Research Head of Global Equities Director of Financial Planning

Patrick J. Cronin, CFA, CAIA Warren D. Pierson, CFA Laura K. Thurow, CFADirector Managing Director Managing Director Institutional Consulting Baird Advisors, Sr. PM Co-Director of PWM Research, Prod & Svcs

William A. Delwiche, CMT, CFA Director Investment Strategist

Appendix – Important Disclosures

Disclaimers

This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. Foreign and emerging market securities may be exposed to additional risks including currency fluctuation, political instability, foreign taxes and regulations and the potential for illiquid markets. Historically, small and mid-cap stocks have carried greater risk and have been more volatile than stocks of larger, more established companies. ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST. The Dow Jones Industrial Average, S&P 500, S&P 400, MSCI EAFE, Lehman U.S. Aggregate Benchmark, Lehman Municipal Bond Benchmark, Russell 1000, Russell Mid Cap, Russell 2000, and Russell 3000 are unmanaged common stock indices used to measure and report performance of various sectors of the stock market; direct investment in indices is not available. Baird is exempt from the requirement to hold an Australian financial services license. Baird is regulated by the United States Securities and Exchange Commission, FINRA, and various other self-regulatory organizations and those laws and regulations may differ from Australian laws. This report has been prepared in accordance with the laws and regulations governing United States broker-dealers and not Australian laws. Copyright 2015 Robert W. Baird & Co. Incorporated.

Other Disclosures

UK disclosure requirements for the purpose of distributing this research into the UK and other countries for which Robert W Baird Limited holds an ISD passport. This report is for distribution into the United Kingdom only to persons who fall within Article 19 or Article 49(2) of the Financial Services and Markets Act 2000 (financial promotion) order 2001 being persons who are investment professionals and may not be distributed to private clients. Issued in the United Kingdom by Robert W. Baird Limited, which has an office at Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB, and is a company authorized and regulated by the Financial Conduct Authority. For the purposes of the Financial Conduct Authority requirements, this investment research report is classified as objective. Robert W Baird Limited ("RWBL") is exempt from the requirement to hold an Australian financial services license. RWBL is regulated by the Financial Conduct Authority ("FCA") under UK laws and those laws may differ from Australian laws. This document has been prepared in accordance with FCA requirements and not Australian laws.

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September Investment Strategy Outlook