Financial Markets Outlook

Financial Markets Outlook 10th Annual Rocky Mountain Economic Summit Victor, Idaho July 12, 2018 Bill Kennedy, CFA Chief Investment Officer

Investment Observations 1. Global liquidity is shrinking 2. Real interest rates are rising 3. This economic cycle has another year to run but a U.S. recession is highly likely in the next three years 4. Coming populist backlash

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Global Liquidity is Being Drained

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Global Liquidity: Central Bank Liquidity is Shrinking Central bank asset growth rate is -1%; QT is working Cumulative assets of the top 6 global central banks (US$ billions) Source: St. Louis Fed, Fieldpoint Private 25,000

Central Bank Assets % YoY 25%

20%

20% 20,000

15%

15%

13%

10%

7%

SNB

ECB

BOJ

PBOC

Fed

11%

9%

5%

BOE

3%

3%

14

15

$21.3 trillion

$20.1

0% -1%

-5% 15,000

10

11

12

13

16

17

18 (est)

10,000

5,000

0 2004

Source: Citi Research, Bloomberg, Fieldpoint Private 05

06

07

08

09

10

11

12

13

14

15

16

17

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18 (est)

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Global Liquidity: Shortage of U.S. Dollar Liquidity

Tax Reform

Source: Citi Research, Bloomberg, Fieldpoint Private

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Real Interest Rates are Rising

Positive real yields

Negative real yields

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Higher Real Interest Rates = Lower Asset Values

Higher discount rates decrease valuations

Building blocks of the discount rate EQUITY CREDIT SOVEREIGN

Discount Rate

Asset Fair Value Real policy rate

Inflation premium

Term premium

Credit risk premium

Equity risk premium

Source: PIMCO, Fieldpoint Private

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This Is The Second Longest Cycle on Record

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U.S. Economy Consistent With Our 3% Growth Outlook U.S. economic and inflation data is weakening

No signs of an immediate recession

Citi Economic Surprise Index, Citi Inflation Surprise Index, U.S. Source: Bloomberg, Citigroup, Fieldpoint Private

U.S. durable goods new orders (ex transportation) Source: Bloomberg, US Census Bureau, Fieldpoint Private

 Retail and consumer spending are soft. Manufacturing shifted into high gear with a pick up in industrial activity. Higher goods production is leading to higher freight volumes.  Loan demand is picking up. Banks are competing, but funding costs are rising faster than lending rates = margin squeeze (lower NIM). Delinquency rates are stable.  Prices already rising for steel, aluminum, lumber, cement, labor, construction and transportation.

Tariffs will raise prices for equipment/machinery and hurt prices for agricultural commodities.

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Global Economic Momentum Slowing (OECD Leading Economic Indicators)

AUS AUT BEL CAN CHE CHL CZE DEU DNK ESP EST FIN FRA GBR GRC HUN IRL ISR ITA JPN KOR MEX NLD NOR NZL POL PRT SVK SVN SWE TUR USA

1Q17 1.65 1.31 -1.79 1.07 1.39 -0.51 -1.31 1.39 1.08 1.44 -1.43 1.07 1.15 0.56 -0.71 1.27 1.02 1.16 -1.20 1.00 1.33 -1.23 1.24 1.02 1.40 -1.92 1.84 -0.87 0.63 1.25 1.74 1.01

2Q17 0.54 1.25 -1.04 0.94 1.29 1.64 -1.32 1.42 1.24 -1.77 -0.75 1.29 1.37 -1.40 1.22 1.03 -0.91 -1.60 1.83 1.32 0.20 -0.99 0.94 0.26 1.45 -1.56 1.53 1.69 -1.53 0.94 1.48 0.14

3Q17 -1.51 1.27 1.77 1.54 1.28 1.23 -1.01 1.24 0.96 -0.59 1.69 0.77 0.83 -1.65 -1.76 0.87 -1.47 0.04 1.45 1.21 -1.62 -1.14 1.48 1.78 1.37 -1.14 0.37 1.21 -0.35 -1.39 0.99 1.90

4Q17 -1.60 1.19 1.01 0.56 0.72 1.16 -1.76 0.48 -0.61 1.25 -1.87 -1.76 -1.84 -1.39 -0.95 -1.68 -1.49 1.45 0.93 -1.62 -1.39 -1.70 0.90 1.37 0.84 -1.00 -1.56 0.89 1.02 -1.60 -1.58 1.48

1Q18 -1.44 0.08 -1.78 -1.66 -1.71 1.13 -1.21 -1.66 -1.66 -1.82 -1.45 -1.56 -1.56 -1.47 1.62 -0.20 -1.54 0.72 -1.72 -1.59 -1.23 -0.89 -1.78 0.75 1.89 -0.56 -1.32 -1.75 -1.75 -1.26 -1.51 1.27

2Q18 -1.49 -1.90 -1.67 -1.67 -1.81 -0.23 -1.20 -1.54 -1.65 -1.11 -1.43 -1.44 -1.65 -0.97 -0.52 -0.18 -1.43 1.76 -1.75 -1.09 -1.17 0.71 -1.44 0.30 0.87 2.02 -0.08 -1.82 -1.47 -0.95 -1.57 0.95

LEI momentum is slowing

LEI momentum is accelerating

Source: OECD, Fieldpoint Private Please See Important Disclosures in Back of Presentation

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The Rise of Populism

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Drivers of Populism: Hollowed-Out Living Standards Real Disposable Personal Income per Capita Ten year % change, a.r. 1970-2018 Source: Federal Reserve Bank of St. Louis, Fieldpoint Private 5%

4%

3%

2%

1%

0%

Source: Hoisington Investment Management, Quarterly Review and Outlook – 4Q2016 Please See Important Disclosures in Back of Presentation

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Drivers of Populism: Broken Social Contracts

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Manifestations of Populist Backlash •

Protectionism and de-globalization

•

Economic nationalism

•

Aggressive fiscal spending

•

Loss of central bank independence

•

Wealth redistribution from winners to the losers of globalization and digitalization

•

New and higher taxes on wealth / assets

•

Universal basic income

Lower Growth + Higher Inflation = Stagflation!

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Investment Outlook – 12 Month View The Three “D’s” 1. Summer Doldrums 2. Trade Détente 3. Deliverance (2019)

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Fieldpoint Private Risk Radar This chart shows the number of standard deviations from the mean each metric is on a given day

Elevated risk

Unusually quiet

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Assets Behave Differently Across Macro Regimes

4Q18 3Q18

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Different points of the cycle require different allocations

     

Early cycle

Low quality / high beta stocks Industrials Emerging markets HY credit Hedged equity Private equity

        

Mid cycle

Growth stocks Tech Banks IG credit Converts/Preferred Hedged equity Commercial real estate

   

Late cycle

Cash High quality / low beta stocks Insurance stocks Floating rate notes Hedged credit Commodities including gold

We are here

Source: Fieldpoint Private

Internal Use Only Please See Important Disclosures in Back of Presentation

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Commodity Prices Relative to Stocks are at Multi-Decade Lows

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Commodity Prices are Already Low

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Key Takeaways 1. We have entered the dark phase of central bank intervention – the unwinding.

Monetary normalization will test the financial system through a series of mini-crises and market turbulence.

2. Global liquidity is shrinking due to (a) quantitative tightening (QT) and (b) tax reforms. This is putting upward pressure on the U.S. dollar, a major risk to the dollarized global economy. We expect weaker USD post midterms.

3. Real yields will rise as monetary policy normalizes and fiscal policy picks up.

Expect lower returns and higher volatility of asset prices. There will be greater differentiation between good and back capital allocators. Active management will begin to outperform index-based investing.

4. This economic cycle has another year to run but a U.S. recession is highly likely in the next three years The corporate profit cycle is alive and well until wage growth reaches 4%. The credit cycle will turn before the equity cycle.

5. A populist backlash will manifest itself through economic nationalism, protectionism, increased fiscal spending, and loss of central bank independence 6. Near-term outlook: the three “D’s” - doldrums, détente and deliverance.

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The Time to Prepare for a Bear Is Before It Arrives

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