Economic Implications: Market Forecasts

5 Forces Poised to Shape Global Markets


1. How many times in the past 25 years has the S&P 500 finished with a calendar-year loss?

2. In the past 25 years, the Russell 2000 Index of small-cap stocks has an annualized average return of 10.5%. In how many of those years did it finish with a calendar-year return between 5% and 15%?

Financial Market Trivia Part 1

A. 2 C. 8B. 4 D. 12

A. 0 C. 10B. 5 D. 15


1. High Current Valuations Imply Lower Future Returns

2. Central Banks Push the Limits

3. Growing Consumer Strength Boosts the U.S.

4. A New Normal for Oil is a Significant Positive (for most)

5. China Slowing But Still Rising

5 Forces Poised to Shape Global MarketsP/E Ratio: A Valuation Measure

Price Price per Share PEarnings Earnings per Share E

• A P/E of 10 indicates that the price is 10 times as large as the earnings• A high P/E may indicate that earnings are depressed or that

expected growth is high• A low P/E may suggest that earnings growth is expected to be low

For illustrative purposes only. Source: Morningstar, Inc.

5 Forces Poised to Shape Global MarketsBargain Hunting in Equities: U.S. Large Caps Look Expensive

For illustrative purposes only. An index is unmanaged and not available for direct investment.

5 Forces Poised to Shape Global MarketsBargain Hunting in Equities: Small Caps Similarly Expensive


5 Forces Poised to Shape Global MarketsBargain Hunting in Equities: Overseas Somewhat Cheaper


5 Forces Poised to Shape Global MarketsBargain Hunting in Equities: Emerging Markets Relatively Cheap


5 Forces Poised to Shape Global MarketsBargain Hunting in Equities: No Comfort From the Long View

For illustrative purposes only.

5 Forces Poised to Shape Global MarketsBargain Hunting in Equities: Declining Earnings Have Boosted P/Es


5 Forces Poised to Shape Global MarketsBargains in Bonds? History Suggests No!


5 Forces Poised to Shape Global MarketsDeveloped-Market Bond Yields are Even Lower Outside the U.S.


5 Forces Poised to Shape Global MarketsHigh Yield Bonds More Attractive, but Defaults Rising

Source: BofA Merrill Lynch. For illustrative purposes only.

5 Forces Poised to Shape Global MarketsHigh Current Valuations Imply Lower Future Returns


• Valuations for U.S. stocks look expensive– Trailing P/Es on the S&P 500 are at 20 times earnings– The Shiller cyclically-adjusted P/E ratio makes the S&P look more expensive– High P/E ratios wouldn’t be daunting if earnings were depressed, but the

energy sector is the only major drag, and profit margins are above average• Foreign-developed equities are cheaper, and more potential for earnings recovery

– Emerging-markets equities appear relatively cheap and reasonable in absolute terms, yet earnings have been declining

• No bargains in government bonds– U.S. yields only look attractive when compared to developed-market peers’

• High-yield bonds offer higher returns, but default risk remains


1. About how much has the Fed increased its balanced sheet since January 2008?

2. What is the cumulative gain (not annualized) in the S&P 500 from the day it hit bottom in March 2009 through August 31, 2016?


A. 75% C. 200%B. 150% D. 275%

A. $36 billion C. $3.6 trillionB. $360 billion D. $36 trillion







• Most central banks have a mandate to keep the currency stable – control inflation

– The U.S. Federal Reserve also has a dual mandate toward

• 1. maximum employment

• 2. moderate long-term interest rates

• A stable currency doesn’t mean zero inflation

– 0% inflation is too close to deflation for central bankers, so 2% inflation is “stable”

• Quantitative easing, once considered extra-ordinary, has now become common place

– Central banks print money to buy assets (usually bonds) and hope that cash is reinvested in the economy, stimulating growth

– U.S., U.K., Japan, and the European Central Bank all have their programs

5 Forces Poised to Shape Global MarketsPolicy Mandates for Central Banks

5 Forces Poised to Shape Global MarketsEasing in Japan is Extreme Relative to the U.S. & Europe

Source: Federal Reserve, European Central Bank, and Bank of Japan. © 2016 Morningstar. All Rights Reserved.

1. Expand the money supply – this hasn’t worked, as banks sat on cash and M2 (a measure of the money supply) remained mostly flat

2. Lower bond yields – no clear cut decline, 10-year yields rose in U.S. during QE33. Asset appreciation – QE does seem to have raised stock-market prices, but not as impactful in

real estate, and boost to GDP from “wealth effect” seems small4. Lower exchange rates – Yen depreciated dramatically in early 2013, as the euro did in late

2014, but everyone can’t depreciate together because rates are relative5. Higher inflation expectations – evidence is limited that QE raises inflation expectations

• QE is no economic cure-all. Currency depreciation can boost exports, but the impact on business investment and consumer spending appears small• QE continues as long as central banks don’t sell their assets, exit plans uncertain• Former Fed chief Bernanke often called on fiscal policy to supplement monetary policy

5 Forces Poised to Shape Global MarketsPotential Benefits of Quantitative Easing (QE)

Five Forces Poised to Shape Global MarketsGlobal Growth Remains Sluggish Despite Easing

Source: World Bank. © 2016 Morningstar. All Rights Reserved.







5 Forces Poised to Shape Global MarketsIncreased Employment is the First Step to More Spending


• Steady recovery in private payrolls since the early 2010 bottom

• Only one month since Feb 2010 when private payrolls lost ground

• 6.3 million more private sector jobs now than at the pre-crisis peak of Jan 2008

5 Forces Poised to Shape Global MarketsPace of Employment Gains is Increasing


• Annual pace of job growth has slowed

• The slowdown is expected with the unemployment rate below 5%

• With the economy close to “full employment,” wage inflation is more likely

5 Forces Poised to Shape Global MarketsWage Growth Trending Higher


• Wage growth shifted higher from 2% to 3% in past 2 years

• Headline unemployment is low at 4.9%

• The broader U-6 measure of unemployment is 9.7%, well above pre-crisis lows near 8%

Housing Demand May Be A Long-Term Growth DriverNew construction crashed as the housing bust sent home prices lower. But after a low in 2009, housing has been on an uptrend. Pent up demand suggests that the housing rally could last, although more of the recent growth has been in multi-family units, not single-family

Source: Census Bureau, Morningstar Calculations. For illustrative purposes only.


1. How many millions of barrels of oil are produced globally each day?

2. How big was the energy sector as a percentage of the S&P 500 as of August 31, 2016?


A. 59 million C. 59 billionB. 95 million D. 95 billion

A. 3% C. 10%B. 7% D. 15%







5 Forces Poised to Shape Global Markets10-Year History of Oil Prices


• The price of oil has fallen more than 70% from its three-year high ($110) by early 2016

• In 2008 “Peak Oil” caused a price surge, but the global financial crisis sliced demand growth, and prices fell

5 Forces Poised to Shape Global MarketsGlobal Production Outpaces Global Demand


• Supply and demand were in balance until mid-2014

• Production growth outstripped rising demand growth, by nearly 2 million barrels per day by the end of 2015

5 Forces Poised to Shape Global MarketsGlobal Production Outpaces Global Demand


• U.S. production increased by 3.7 million barrels a day from the end of 2011 to its 2015 peak

• Falling oil prices have begun to reduce U.S. production

5 Forces Poised to Shape Global MarketsMore Production at Home = Fewer Imports


• U.S. economy benefits as fewer dollars are shipped overseas

• Global consumers benefit from lower transportation costs

5 Forces Poised to Shape Global MarketsOil Inventories are Up in the Rich World


• The result of production exceeding demand is higher inventories…and falling prices

• Industry-level impact–Winners: airlines, trucking, energy-intensive industrials, retailers, commuters– Losers: exploration & production, energy services, alternative energy, energy

finance, energy-related manufacturing (of drilling rigs and pipes)

• Country-level impact–Winners are the energy importers – Japan, Europe, U.S., China, India– Losers are the energy exporters – Middle East, Russia, Venezuela, Brazil,

Canada

• Overall macroeconomic impact – lower oil prices have increased stock-market volatility and hurt energy-related industries, but cost savings are clearly positive for consumer spending, which will bubble up through a host of industries

5 Forces Poised to Shape Global MarketsSpotlight on Energy – Winners and Losers

• Focus on supply growth from key OPEC countries:– Saudi Arabia has increased production 200,000 bpd year over year– Iraq has increased production by 400,000 bpd year over year– Iran has increased production by 800,000 bpd year over year

• U.S. producers cut costs to the bone to stay in business– High sunk costs mean that production continues for a while even after prices drop

• Global producers slash exploration and operating costs to stay afloat– Cuts to capital spending started in 2015, with more cuts in 2016– Less exploration will eventually take a toll on new supply

• Continued demand growth should push prices higher, although price increases will be capped by flexible U.S. producers

5 Forces Poised to Shape Global MarketsWhat’s Next for Energy?


1. What is the population of China?

2. The U.S. has 10 cities with a population in excess of 1 million. How many does China have as of the 2010 census?


A. 19 C. 89B. 49 D. 179

A. 140 million C. 820 millionB. 410 million D. 1.4 billion







5 Forces Poised to Shape Global MarketsChina is the Great Growth Story of Our Generation


5 Forces Poised to Shape Global MarketsChina is Gaining Rapidly on the U.S. as the World’s Largest Economy


5 Forces Poised to Shape Global MarketsMassive Migration off the Farm…


5 Forces Poised to Shape Global Markets…And into Cities


5 Forces Poised to Shape Global MarketsPer Capita GDP Still Lags Far Behind Developed Countries


• Investment-led GDP growth appears unsustainable• Exporting growth is limited due to its large share of existing

manufacturing base•Massive local government debt, that arose from heavy

investment in real estate and infrastructure, is a major hurdle• Rapidly aging population caused by the one-child policy will

stress the social safety net• A transition to a consumer-driven economy is a long way off• Can economic freedom be maintained without political and

religious freedom?

5 Forces Poised to Shape Global MarketsChina Faces Many Challenges for its Next Growth Phase

• Look beyond US equities and core bonds for higher returns–Emerging-markets equities, EAFE stocks, credit-sensitive bonds–Safe looks expensive: REITs, dividend payers, government bonds

• Influence of monetary easing wanes• Consumers keeps US on track for modest growth• Energy prices recover as markets rebalance

–But $100 oil is unlikely• China is the biggest swing factor in global markets – big risks and

even bigger opportunity

5 Forces Poised to Shape Global MarketsTakeaways

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Economic Implications: Market Forecasts