LEADER CAPITAL NEWS 2015 Outlook: The Corporate Rebound

2015 Outlook

We ring in the New Year much as 2014 ended. The treasury market has

continued its robust rally, especially on the long end of the curve. Equities

have exhibited continued volatility, as the VIX index has remained elevated,

and recently eclipsed the 20 mark again. Oil has remained weak, with WTI

trading as low as $45 per barrel. And corporate credit has remained soft, as

the market digests a host of uncertainty, not the least which is the energy

market.

So where is there value? What will 2015 bring? Leader Capital views the

latest sell-off in corporate credit as a screaming buy. The yield curve will

likely continue to flatten as the Federal Reserve embarks on raising rates.

Oil will find a bottom at some point during the year, and many oil related

bonds have already put in a bottom. Equities will benefit from long-

awaited revenue growth and PE multiple-expansion, but will do so amongst

elevated volatility

Corporate Bonds: Recent Pull back is a Buying Opportunity

Leader Capital’s investment thesis has not changed. Against the backdrop

of an improving U.S. economy, second-half of 2014 correction in corporate

credit offers an attractive entry point. Such sell-offs in corporate bonds

have occurred to varying degrees in each of the last three years, all of which

were proven to be great buying opportunities. We expect broad-based

corporate spreads, both High Yield and Investment Grade, to narrow in

2015, reaching, and in many cases eclipsing, the low levels seen in the

middle of 2014. Additional spread widening is highly unlikely given that

the United States will not be entering a recession over the next 12 months.

Chart 1 illustrates that pro-longed corporate sell-offs generally only occur in

recessionary environments. Otherwise, the “buy-on-dips” mentality has

been a profitable strategy.

Energy Carnage: The Baby and the Bathwater

Chart 2 illustrates the dynamic move lower in the Energy space. The

plummet in West Texas Crude, and to some extent Natural Gas, is a

formidable headwind for all issuers in the space. Still, the Energy High

Yield Spread Index has increased from 375 bps in June, to almost 1050 bps

in December.

Such a sell-off does not occur without opportunity. In many cases, the baby

has been thrown out with the proverbial bathwater. Leader Capital has

been adding to and initiating positions in Investment Grade, and BB-rated

companies that can weather a pro-longed period of lower oil prices. We are

concentrating on names with less leverage, more liquidity, and have large

amounts of their production hedged through 2015. Midstream and MLP

names, whose performance is less leveraged to the price of oil, also look

attractive.

In terms of the price of oil, predicting a bottom can be difficult, especially in

the face of the 1.5mm BPD supply/demand imbalance that the market is

currently experiencing. However, RIG counts have already come down

drastically (chart 3), and at this rate will come down the same percentage as

they did in 2008 within the next few months.

Contango in the Futures Curve is large enough to allow speculators to buy

spot, store it, and short forwards for delivery further out on the curve. The

lack of marginal supply going forward as high cost producers cut back

production, coupled with demand increases at these lower levels will bring

the market back into equilibrium and support higher prices. But this does

not happen overnight. The Oil Market and the stocks and bonds of energy-

related issuers will react well before the supply/demand imbalance is

resolved. Oil can go lower, but Leader Capital expects the average price for

2015 to be much higher than it is right now.

The Federal Reserve: Who is Fighting the Fed?

Janet Yellen and the Federal Reserve are intent on more normalized

monetary policy. They are not “tightening,” they are “normalizing.” There

are many times over the course of U.S. history where the unemployment

rate was 5.6% and core inflation was running at 1.3%. During all of those

times, the Fed Funds rate was not as low as it is today. The Federal Reserve

is intent on normalizing monetary policy and bringing an end to the

monetary experiment upon which they have embarked over the last six

years. They will do so carefully, and telegraph their moves, since much is at

stake. We are taking their “dots” at face value, and think that a 2015 rate

move is inevitable. Chart 4 illustrates where Federal Reserve members

expect the Federal Funds rate to be at the end of 2015. This contrasts the

December Eurodollar Futures market which puts three-month LIBOR at

0.66% by the end of the year. It seems that the market has decided the

proper path for the Federal Reserve, so much so, that it is ignoring the

commentary from actual voting members.

The Fuel is Fuel

So where are market participants getting the fuel for their argument that

the Federal Reserve need not normalize monetary policy? The fuel is fuel.

Producer Costs, as well as Consumer Costs, most notably the price of

gasoline, will keep inflation in check and allow for zero percent interest

rates as far as the eye can see. A word of caution surrounding this line of

thinking is in order: The Federal Reserve has been quite clear in their

message that they will focus on core inflation, ex-food and energy. Not only

have they stated this, but their actions have also reflected it. In 2011, when

top-line inflation rates were well above 3%, Bernanke continually dismissed

such elevated levels as “transitory,” and resisted the call for higher rates.

The ECB did the opposite, began tightening, and, in retrospect, forced the

EU back into recession. Why, now that transitory prices are bringing down

top line inflation rates, should the Federal Reserve alter their stance and

delay tightening? They won’t, since they decided long ago that it is unwise

to let a commodity that can fall 50% in six months dictate monetary policy.

Is Inflation Dead?

We will be the first to admit that core inflation has remained subdued, for a

far longer period than we expected. Chart 5 shows core inflation rates have

stayed between 1 and 2 percent over the last 6 years. Meanwhile, pundits

continue to beat the drum that the United States is going to import

deflation, or at least disinflation from abroad. A stronger dollar will make

imports cheaper, however, imports are only -15% of GDP. Goods and

Services in the U.S. make up 70% of the economy and are far more

important for core inflation. The average U.S. household is expected to

spend an average of $750 less in 2015 on gasoline. Those savings at the

pump are likely to find their way into both savings and the purchases of

core goods and services, and add buoyancy to the core inflation rate during

the year. Perhaps more important is the tightening labor market and

wages. Sustainable core inflation is almost always accompanied by

accelerated wage growth, something that has been largely absent in the

slow economic recovery from 2009 until today. However, just because it

has been absent thus far, does not mean that subdued wages will continue

to afflict the U.S. labor force. Chart 6 indicates that historically, when the

unemployment rate (orange line) dips below 6% (black line) there is

accelerated wage growth (blue line) over the next couple of years. The

unemployment rate is currently at 5.6%--food for thought.

We also know that the corporate sector is desperately looking to hire. The

JOLTS survey (chart 7) shows that there are the most job openings since

2001. U.S. workers are in a better negotiating position than they have been

for years—a necessary pre-cursor to accelerated wage growth.

The Yield Curve: Implications for Flattening

So if short term rates are going to creep higher over the next twelve months,

what is going to happen to the long-end of the yield curve? Chart 8 shows

the 2-10 and 10-30 spreads. Both show how much the curve has flattened

over the last twelve months—130bps and 30bps respectively. We expect the

curve to continue to flatten as the Federal Reserve raises short term rates.

There continues to be a huge supply-demand imbalance on the long-end of

the curve. First, the Federal Reserve owns 50% of all of the treasuries with

a greater than ten year maturity. Second, there continues to be heavy

demand for high quality long duration assets from Pension Funds and

Insurance companies, as they balance their longer duration liabilities.

Many are total return agnostic and will continue to buy regardless of the

real return prospects of treasuries. But while longer treasury rates could

continue lower in the short term, they do not offer a good long-term risk

reward trade-off.

Longer duration treasuries have already lost their relative value appeal.

The S&P 500 already offers a dividend yield 40 bps higher than the yield on

a ten year treasury. Chart 9 shows how rare this is historically, especially

given the tax-effective nature of dividends.

If one looks at the price a treasury investor is paying for next year’s coupon

(chart 10), treasury valuations are in nosebleed territory. This doesn’t

mean they can’t go higher, but we think there are better values out there.

We have been extending maturities in the aforementioned energy sector in

our Total Return Fund as a safer duration bet.

Leader will continue to monitor the yield curve as it is the single most

important leading indicator for the economy. In fact, every recession over

the past fifty years has been pre-empted by a flat or inverted yield curve

(chart 11). The Federal Reserve, historically, has had very little effect on the

long-end of the yield curve. However, given that they own half of all the

outstanding treasury maturities, they do have the ability to steepen the

yield curve by lightening up their balance sheet. If the yield curve begins to

flatten out or invert at low levels, we think that the Federal Reserve would

not hesitate to utilize such a policy so as to stave of recession. The effect

would be two-fold: one, they would steepen the yield curve and foster the

credit expansion that is currently underway, and two, they would have

more potential for QE in the next downturn.

Leader Capital Positioning

Higher shorter term rates mean floating rate corporate bonds, which float

off of three-month LIBOR, will increase the yield of the portfolio as the

Federal Reserve raises rates. We have chosen to largely bypass the Senior

Bank Loan market since many of those issues have LIBOR floors at or

above 100 bps. This means that the Federal Reserve will have to raise rates

at least three times in order for investors to see an uptick in coupon.

Furthermore, much of the leveraged loan issuance has been covenant light.

As a result, we have decided to get our floating rate exposure primarily

through investment grade issues, both corporate issuers, and CLO 1.0

mezzanine tranches that are rapidly being paid down. As of January 31,

2015, 35% of the Short Term Bond Fund was floating rate. In both funds

we have extended duration in the energy sector primarily in issuers that

have low leverage, hedged production, and solid liquidity. As of January 31,

2015, the Leader Short Term Bond Fund had a 12.6% exposure to energy,

and the Total Return Fund had 15.6%.

This material contains the current opinions of the author but not necessarily those of Leader Capital and

such opinions are subject to change without notice. This material has been distributed for informational

purposes only and should not be considered as investment advice or a recommendation of any particular

security, strategy or investment product. Statements concerning financial market trends are based on

current market conditions, which will fluctuate. There is no guarantee that these investment strategies will

work under all market conditions, and each investor should evaluate their ability to invest for the long-term,

especially during periods of downturn in the market. Information contained herein has been obtained from

sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

Risks:

Investments in debt securities typically decrease in value when interest rates rise. This risk is actually

greater for longer-term debt securities. Investment by the fund in lower-rated and nonrated securities presents a greater risk of loss of principle and interest than higher-rated securities. The fund is exposed to

credit risk where lower –rated securities have a higher risk of defaulting on obligations. Investments in

foreign securities involve greater volatility and political, economic and currency risks. They may also have different accounting methods. Investments in asset-backed and mortgage-backed securities include

additional risks that investors should be aware of such as credit risk, prepayment risk, possible illiquidity

and default, as well as increased susceptibility to adverse economic developments.

Investors should consider the investment objective, risks, charges and expenses of the Fund carefully

before investing. The Prospectus contains this and other important information about the Fund. For

a current Prospectus, call 800-269-8810 or go to www.leadercapital.com. Please read carefully before

investing.

Foreside Fund Distributor, LP.

Leader Capital manages the Leader Short-Term Bond Fund (LCCMX/LCCIX/LCAMX/LCMCX) and the

Leader Total Return Fund (LCTRX/LCTIX/LCATX/LCCTX).

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