PRESENTED BY Epoch’s Quarterly Capital Markets Outlook William W. Priest, CFA Kevin Hebner, PhD Chief Executive Officer Global Investment and Co-CIO Strategist June 26, 2018 | The webinar replay is available on our website: www.eipny.com The inform ation contained in this presentation is distributed for inform ational purposes only and should not be considered investm ent advice or a recommendation of any particular security, strategy or investm ent product. Inform ation contained herein has been obtained from sources believed to be reliable, but not guaranteed. The information contained in this presentation is accurate as of the date submitted, but is subject to change. Any perform ance information referenced in this presentation represents past perform ance and is not indicative of future returns. Any projections, targets, or ents and are based on Epoch’s research, analysis, and assum estim ates in this presentation are forward looking statem ptions made by Epoch. There can be no assurances that such projections, targets, or estim ates will occur and the actual results m ay be materially different. Other events which were not taken into account in form ulating such projections, targets, or estim ates m ay occur and may significantly affect the returns or perform ance of any accounts and/or funds m anaged by Epoch. To the extent this presentation contains inform ation about specific com panies or securities including whether they are profitable or not, they are being provided as a m eans of illustrating our investm ent thesis. Past references to specific com panies or securities are not a com plete list of securities selected for clients and not all securities selected for clients in the past year were profitable.
U.S.: Strengths, Weaknesses, Opportunities and Threats STRENGTHS • Culture : Commitment to innovation, free-market capitalism, allowing consumers to determine winners & losers. • Tech : The U.S. is easily the world leader (except-FinTech and Robotics). • Economic cycle : Turbo-charged by triple-whammy of: strong global recovery; fiscal stimulus (TCJA); and loose financial conditions (including negative real policy rates). • Earnings growth & buybacks : 19% this year (7 ppts reflecting TCJA), with buybacks historical high of $800bn. • Deregulation : A key focus of this administration (e.g., banking, energy), often under-the-radar. WEAKNESSES • Fiscal deficit and other imbalances : 2019's budget deficit is likely to be its largest ever (as % of GDP), outside of recessions and wartime. One reasons is that entitlement reform is challenging, the third rail of U.S. politics. Further, the trade balance is approaching its historical worse level, as is the personal savings rate. • Valuations : Above historical averages. OPPORTUNITIES • New Tech : The pace of innovation is accelerating; the US should lead the march (vs most of China's 2025 ambitions), with a very positive impact on profitability. • Fast-growing emerging markets: Opportunities for U.S. MNCs and exports of goods and services. THREATS • Trump and Trade : Key issues are market access, IP and China's state-driven economic model. China to retaliate. • President Xi and China 2025: Aims to be a strategic competitor. China is challenging the U.S.'s lead in sectors such as AI, autonomous vehicles, electric vehicles & batteries, aviation, robotics, renewable energy, and bio-tech. Already leagues ahead in FinTech. • The risk of higher interest rates : The looming trifecta of QT, soaring fiscal deficits and the wall of maturities. Source: Epoch Investment Partners 2
U.S. Employment is Now in its 8 th Year of Solid Growth Very tight labor market: Suggests higher wage growth 2.9 3.5 4.0 2.7 4.5 2.5 5.0 As output gap closes, inflation begins to tick 2.3 5.5 up, typical of a late cycle 6.0 4 2.1 6.5 3 1.9 7.0 2 1.7 7.5 1 0 Wage indicator average (%) Shadow labor (U6-U3, %, rhs, inverted) -1 -2 Source: Bloomberg, Epoch Investment Partners As of May 31, 2018 Note: U6 includes U3 + those only marginally attached to labor force (not looking, but would if labor market improved) + those working part-time for economic reasons. The "Wage indicator average" is the mean of four series: Atlanta Fed, NY Fed Median, Core CPI Core CPI services AHE, ECI. Core CPI goods Fed 2.0% target Source: Bloomberg, Epoch Investment Partners As of May 31, 2018 3
Tight Labor Means a Hawkish Fed: And an Inverted Yield Curve? Fed projects five hikes by end-2019, with a few more to come in 2020 3.5 3.0 2.5 2.0 This time is different? If the yield curve 1.5 inverts, a recession inevitably follows 1.0 3.0 0.5 2.0 0.0 1.0 Effective FFR (%) 0.0 Current Fed Funds Futures (%) FOMC forecast (%) -1.0 -2.0 Source: FRB, Bloomberg, Epoch Investment Partners As of May 31, 2018 Recessions Yield curve slope (10s - 2s, %) Yield curve slope (30s - 5s, %) Source: Bloomberg, Epoch Investment Partners As of May 31, 2018 4
U.S. Equity Multiples: Unlikely to Improve Given Transition to QT S&P 500 only marginally expensive vs post-1990 median 30 25 20 QE FCF yield: Close to historical median 12 15 10 10 8 6 S&P 500 Forward PE Post-1990 median 4 Source: Bloomberg, Epoch Investment Partners As of May 31, 2018 2 0 S&P 500 FCF yield Post-1990 median Source: Bloomberg, Epoch Investment Partners As of May 31, 2018 5
U.S. Tech: The Sector has Outperformed for Eons, but Valuation is In-line with Historical Norm as FCF Growth has Kept Pace Tech isn't expensive vs. history; trading close to its post-1990 median FCF yield 10 8 6 Tech FCF yield vs S&P 500: Trading just above its historical median 4 225 200 2 175 150 0 125 100 Tech FCF yld (%) Post-1990 median (%) 75 50 Source: Bloomberg, Epoch Investment Partners As of May 31, 2018 25 0 Tech FCF yld vs S&P 500 (%) Post-1990 median (%) Source: Bloomberg, Epoch Investment Partners As of May 31, 2018 6
Is e-Commerce the 2 nd Largest Bubble of the Last Four Decades? Facebook (25k employees) market cap > MSCI India (1.3 bn people) Index 900 800 Gold Nikkei 700 Thailand 600 Tech US Housing 500 China Biotech 400 e-Commerce 300 200 100 Source: Bloomberg, DoubleLine, Epoch Investment Partners As of May 31, 2018 7
Tech is the New Macro: DPI vs CPI Lower inflation online than in the CPI; by 1.3 The DPI is markedly lower than the CPI ppts per year — for the same categories Headline inflation 101 Food & beverages 99 Household goods Apparel 97 ICT Medicine & supplies 95 Transportation 93 Recreation goods Other 91 -7 -6 -5 -4 -3 -2 -1 0 1 2 CPI DPI CPI (index) DPI (index) • The entry of new products implies the CPI overstates true inflation by an additional 1.5 to 2.5 ppts per year. • Combining the two effects suggests the DPI inflation rate is more than 3 ppts per year lower than the CPI inflation rate for the same categories from 2014 – 2017. Source for both charts: "Internet Rising, Prices Falling: Measuring Inflation in a World of E-Commerce," American Economic Association As of May 2018 8
Tech is the New Macro: Implications of a Capital-Light World Return on Equity Components Profit Margin Asset Utilization Leverage 𝐒 OE OE = 𝐘 𝐘 𝐵𝑡𝑡𝑓𝑢𝑡 𝑇𝑏𝑚𝑓𝑡 𝑄𝑠𝑝𝑔𝑗𝑢𝑡 𝐒 OE OE = 𝐘 𝐘 𝐹𝑟𝑣𝑗𝑢𝑧 𝐵𝑡𝑡𝑓𝑢𝑡 𝑇𝑏𝑚𝑓𝑡 Payout ratios to rise 𝑄𝑠𝑝𝑔𝑗𝑢𝑡 with less need for equity to support decreasing 𝐒𝐏𝐅 = asset base requirement Equity Technology will improve all three components Source: Epoch Investment Partners 9
The Impact of Technology on Prices Firms set quantity where MR = MC (point "a") and then set price by moving vertically up to the Demand curve (point "b") Source: Epoch Investment Partners 10
Technology Reduces Frictions, Pushing Marginal Costs Lower: This is Win-Win, Making Both Consumers and Firms Better Off Tech lowers MC so that it now intersects MR at point "c", which is where the firm sets quantity. The new price is set by moving vertically up to the Demand curve (point "d"). Source: Epoch Investment Partners Source: Epoch Investment Partners 11
In a Capital-Light World, Companies Return a Higher Proportion of Cash to Shareholders: 2018 to be a Record Year for Buybacks S&P 500 companies' use of cash Dividends plus buybacks : Accounted for 26% 100 2,600 of cash usage in 2000, surging to 46% in 2018. 80 2,200 Capex : Represented 42 – 44% of cash usage in the early-2000s, vs. only 27 - 28% now. 60 1,800 40 1,400 Proportion of cash usage (%): 20 1,000 Capex falling, shareholder yield rising 50 0 600 45 Capex (%) R&D (%) 40 Cash M&A (%) Dividends (%) Buybacks (%) Total Cash ($ bn, rhs) 35 Source: Goldman Sachs 30 25 Capex (%) Div + bbk (%) Source: Goldman Sachs 12
The Combined Cash Yield is Superior to that Available from Bonds Dividend yield: Roughly 100bp less than the 10Y bond yield 7 6 5 4 Dividend + buyback yield: 1.75 ppts above 10Y yield (reflecting record buybacks) 3 8 2 7 1 6 5 S&P 500 div yld (%) US 10Y yield (%) 4 Source: Bloomberg, Epoch Investment Partners 3 As of May 31, 2018 2 1 US 10Y yield (%) Div + bbk yld (%) Source: Bloomberg, Standard and Poor's, Epoch Investment Partners As of May 31, 2018 13
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