pennsylvania trust economic insights - 4th quarter 2016

Economic Insights4th Quarter Update

October 2016

3rd Quarter Wrap-Up

￭ Broadly defined, commodities (inclusive of oil) was the best performing sector in September. While lined with skepticism, OPEC’s September announcement of a framework deal to cut production should provide a floor to oil prices and will likely push prices higher.

￭ With the exception of European Equities, all major asset classes are now positive on the year.

￭ European markets have remained volatile as most of the developments from earlier in the year (Brexit) continue to weigh on the markets.

￭ Emerging markets have remained a bright spot for investors as rising commodity prices and an accommodative U.S. Federal Reserve boosted speculative investment in the sector.

Source: Bloomberg LLP – Total returns (as of 03/31/2016) are based on USD hedged indices. *“Great Recession” end date used is 03/31/09 which was the low month end point on the S&P 500.

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Performance TableSeptember 3rd Quarter YTD 1 Year 3 Years

Crude Oil7.92

NASDAQ10.02

Crude Oil30.24

Gold17.29

NASDAQ46.46

S&P Commodity4.14

MSCI Emerging Markets

9.03

Gold23.43

MSCI Emerging Markets16.78

S&P 50037.33

NASDAQ1.96

NIKKEI (Japan)8.6

MSCI Emerging Markets16.02

NASDAQ16.54

Dollar19

NIKKEI (Japan)1.6

MSCI European Equity

5.4

High Yield Bonds12.44

S&P 50015.42

MSCI World Equity18.58


1.29


S&P 5007.84

NIKKEI (Japan)12.13

Investment Grade Bonds12.61



NASDAQ7.15



MSCI European Equity0.87

S&P 5003.85



NIKKEI (Japan)10.31




Crude Oil6.99

MSCI European Equity-1.67

Gold0.46

Crude Oil-0.19

S&P Commodity5.3



-1.68Investment Grade

Bonds0.05

Dollar-0.71

NIKKEI (Japan)2.54

MSCI European Equity2.49

Gold-2.14

S&P 5000.02

Gold‐0.74

MSCI European Equity0

Dollar‐0.92

S&P Commodity‐52.83

Dollar‐0.58


Dollar‐3.21


Crude Oil‐52.86

Source: Bloomberg LLP – Total returns (as of 03/31/2016) are based on S&P GICS Level 1 Sector group Indices.

3rd Quarter Wrap-Up￭ Technology, the largest sector by weight in

the S&P 500, was the best performing in the 3rd quarter. Notable names led the index:

Apple +18.9%Amazon +17.0%Google +14.3%Microsoft +13.2%Facebook +12.2%

￭ Defensive sectors (aka low beta) were among the worst performers as capital outflows dampened what has been a good year for Utilities, Telecommunications and Consumer Staples.

￭ Energy rallied to close the quarter as OPEC announced a framework for a deal to curb oil production. Oil rallied 6.5% in September and is now up nearly 40% from its January 20th lows (from $34.54 to $48.34).

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Sector Performance TableSeptember 3rd Quarter YTD 1 Year 3 Years

Energy3.08

Technology12.86

Energy18.72

Telecommunications26.82

Technology62.12

Technology2.44

Financials4.59


Technology22.82

Health Care49.55

Utilities0.39

Industrials4.14

Utilities16.13

Materials22.25

Utilities46.51

S&P 5000.02

S&P 5003.85

Technology12.51

Industrials19.7

Consumer Staples44.48

Industrials-0.11

Materials3.71

Materials11.45

Energy18.96

Consumer Discretionary

38.69


-0.31


2.94

Industrials10.87

Utilities17.37

S&P 50037.33

Health Care-0.51

Energy2.26

S&P 5007.84


Industrials34.64

Telecommunications-0.93

Health Care0.94


S&P 50015.42


Materials-1.25

Consumer Staples-2.63


3.64

Health Care10.71

Financials26.8

Consumer Staples-1.46

Telecommunications-5.6

Financials1.4


9.64

Materials20.8

Financials‐2.72

Utilities‐5.91

Health Care1.37

Financials7.4

Energy‐6.44

2016 Outlook

While indicators disagree, the equity market may experience volatility as monetary, political and geopolitical events unfold.

Markets will need a pickup in profit growth to justify current levels.

As earnings have flat lined, equity valuations have become extended.

Profit growth should improve in fourth quarter and into 2017. Forward p/e valuations look more reasonable.

The timing of Fed tightening may again become an issue as labor and inflation statistics are close to the Fed targets. While the consensus is to move in December, a pick up in economic activity needs to be evident before the Yellen Fed will move.

While the ongoing presidential race will continue to create anxiety and uncertainty, the market has yet to react with heightened volatility.

Intermediate to Long-Term Outlook

While economic indicators continue to confirm that we are in the latter stages of a recovery, we do not expect to see a recession in the next 12 months.

We do not expect any near-term market sell-off to be more than a correction.

Earnings growth will be boosted by lower oil prices and a weaker dollar than a year ago.

The global market may price in an expansion of fiscal spending for 2017 as calls for fiscal austerity become quickly forgotten. Fiscal easing policies will become a headwind for the bond market.

The U.S. economy should continue to move ahead at a modest +/- 2% rate. This should keep inflation in check and create opportunity for corporate profit growth – all supportive of longer-term equity strength.

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Despite a contentious U.S. election, two major global banks under pressure and a pending referendum vote in Italy, volatility has remained low.

BrexitBrexit

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For many global bonds, holding to maturity will guarantee a loss of principal

According to Bloomberg's Global Developed Sovereign Bond Index, 35% of all developed market government bonds are now trading with a negative yield.

71% of the index is yielding below 1%.

While these 35% will provide a negative return over the life of the bond, a small move higher in interest rates has the ability to cause chaos in the bond market.

If interest rates move up 50 basis points (0.50%) the index will lose 4.10%.

If interest rates move up 100 basis points (1.0%) the index will lose 7.92%.

Source: Bloomberg Finance L.P. (Data as of 9/30/2016) 6

0%

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40%

60%

80%

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Under 0%

Global

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Global

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UNITED STATES

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FRANCE

IRELAND

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The S&P 500 has correctly predicted 19 of the past 22 presidential elections. When stocks are higher in the three months prior to the election, the incumbent party wins.

Since August 8th, the market is virtually flat.

Source: Strategas. Data as of 9/30/2016

The current lull in policy uncertainty could lead to lower volatility

The Baker, Bloom and Davis composite index of economic policy uncertainty draws on the frequency of newspaper references to policy uncertainty and to other indicators of policy uncertainty including expiration of tax provisions and disagreement among economic forecasts of inflation and government expenditure.

The correlation to the VIX has generally been positive. Hence, despite political uncertainty, volatility may stay low.

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Bonds add Diversification

In portfolio construction, assets with a strongly negative correlation to other portfolio assets are important diversifiers.

Since the Civil War era, the correlation between changes in stock prices and changes in bond yields has averaged 0%. Over the past five years, the correlation has averaged –0.6%.

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Going back decades, the dollar’s rallies have lasted for long stretches of time. The last one began in 1995 and did not end until 2002. That has some strategists saying the current dollar advance, which started in 2011, is not over despite the currency’s worst quarter in more than three years.

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Above 50 represents growth while below represents a contraction in the industry:

The manufacturing sector struggled in the beginning of the year but rebounded back above 50 until another weak reading in August.

The service sector, while slower than the past few years (consumer alert?), remains in growth mode. If this drops below 50 the market may begin to price in a slowdown.

A manufacturing reading below 45 is more ominous:

Ten of the last 12 times the manufacturing index dropped below 45 coincided with a recession.

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Having tracked earnings growth for the first three years of the recovery, the equity markets have moved ahead since late 2012 on an increase in valuation, due we think, to the now complete quantitative easing.

Threats to liquidity such as “monetary tightening” may have an impact on the markets without a noticeable improvement in earnings.

Earnings growth continues to decline moderately in 2016 providing the rationale for the sideways market.

Our expectation is that profit growth will gradually reaccelerate as consumption improves, federal spending picks up, and additional post election fiscal stimulus occurs, supporting profits.

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After oil found a bottom in January, the year-over-year contribution to inflation will be a positive factor in returning pricing pressures to a level that the Fed would like to see.

The red line demonstrates the year-over-year percent change in the price of oil.

06/30/2015 $62.17 per barrel09/30/2015 $49.66 per barrel12/31/2015 $42.40 per barrel03/31/2016 $41.90 per barrel06/30/2016 $49.01 per barrel09/30/2016 $48.24 per barrel

Oil Prices Inflation and Jobs

CPI readings have also been above 2% all year (ex food and energy).

Unemployment now stands at 4.9%.

Wages had been rising modestly until a decrease in hours worked in August lowered the growth to +1.5% YOY (hours worked * wages per hour)

08/31/2014 $846.98 per week (+2.16%)08/31/2015 $869.15 per week (+2.54%)08/31/2016 $882.54 per week (+1.54%)

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Pennsylvania Trust is not responsible for any loss due to inaccuracies in the information provided. Nothing in this presentation should be construed as investment advice. Please contact a Pennsylvania Trust officer before investing based on this presentation.

Investments and foreign exchange can go up as well as down and involve the risk of loss.

Past performance will not necessarily be repeated in the future.

Certain information in this presentation has been provided by sources believed to be reliable. However, Pennsylvania Trust has had no role in the production or review of such information and makes no warranty, either expressed or implied as to its contents, accuracy or performance.

Through acceptance of the receipt of this presentation, you are acknowledging your understanding and are in agreement with this. If you have any doubt about the suitability of information provided in this presentation, you should contact Pennsylvania Trust or an independent financial adviser for advice.

2016 The Pennsylvania Trust Company

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pennsylvania trust economic insights - 4th quarter 2016

Economy & Finance