Liz Ann
Sonders
Senior Vice President
Chief Investment Strategist
Charles Schwab & Co., Inc.
October, 2013
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“The error of optimism dies in
the crisis, but in dying it gives
birth to an error of pessimism.
This new error is born not an
infant, but a giant.”
–Arthur C. Pigou
1
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Government shutdowns & market impacts
S&P 500 performance before, during and after government shutdowns
Shutdown start
# of days
Week before
During shutdown
1 week after
1 month after
9/30/76
10
-1.6%
-3.4%
-0.2%
-2.8%
9/30/77
12
1.6%
-3.2%
-0.8%
2.7%
10/31/77
8
0.8%
0.7%
2.7%
0.7%
11/30/77
8
-1.3%
-1.2%
-0.3%
-4.2%
9/30/78
17
0.7%
-2.0%
-3.2%
-6.7%
9/30/79
11
-1.0%
-4.4%
-2.8%
-0.9%
11/20/81
2
0.0%
-0.1%
3.7%
0.6%
9/30/82
1
-2.7%
1.3%
7.4%
11.1%
12/17/82
3
-1.5%
0.8%
1.9%
5.5%
11/10/83
3
0.6%
1.3%
-0.3%
-2.0%
9/30/84
2
0.3%
-2.2%
-0.2%
3.1%
10/3/84
1
-2.3%
0.1%
0.9%
3.6%
10/16/86
1
1.6%
-0.3%
-0.2%
1.8%
12/18/87
1
5.9%
0.0%
-1.4%
-2.6%
10/5/90
3
1.8%
-2.1%
-2.0%
0.3%
11/13/95
5
0.7%
1.3%
0.2%
2.0%
12/15/95
21
-0.2%
0.1%
-2.4%
4.0%
3
0.3%
-0.1%
-0.2%
0.7%
% Positive
59%
47%
35%
65%
Median
1970-9/30/13. Source: www.sentimenTrader.com.
2
US & global
economy:
decoupling?
3
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GDP’s components & latest reading
Federal spending now biggest (& only) drag
% of real GDP
1Q13
annualized
Q/Q % change
2Q13
annualized
Q/Q % change
Consumer spending
68.2%
2.3%
1.8%
Government spending
18.5%
(4.2%)
(0.4%)

Federal: 7.4%
(8.4%)
(1.6%)

State/local: 11.1%
(1.3%)
0.4%
(0.3)*
(0.1)*
Net exports of goods & services
(2.7%)

Exports: 12.7%
(1.3%)
8.0%

Imports: (15.4%)
0.6%
6.9%
(1.5%)
6.5%
(4.6%)
4.7%
12.5%
14.2%
0.9*
0.4*
1.1%
2.5%
Fixed investment
 Nonresidential:

15.7%
12.6%
Residential: 3.1%
Change in private inventories
-Real GDP
 2.2% (“new normal”) = average real GDP since June 2009 recession end
 3.2% (“old normal”) = average private sector real GDP since June 2009 recession end
As of 2Q13. *Represents contribution to percent change in real GDP. Numbers may not add up to 100% due to rounding. Source: Bureau of Economic Analysis, FactSet.
4
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US on best & most stable path globally
Change matters more than level to markets
US
Japan
Eurozone
14
6
13
4
12
2
11
0
10
9
-2
-4
8
-6
7
-8
6
2003
-10
2005
2007
China, US and Japan as of 2Q13. Eurozone as of 1Q13. Source: FactSet.
2009
2011
Real GDP (y/y % change)
Real GDP (y/y % change)
China (left)
2013
5
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It’s not déjà vu all over again
Some weakness; but not as sinister as past 3 years
a
b
ISI US Diffusion Index
15
10
5
0
-5
-10
-15
-20
-25
1998
a
20
15
10
5
0
-5
-10
-15
-20
1998
2000
b
2000
2002
2004
2006
2008
2010
2012
ISI Global Economic Diffusion Index
2002
2004
2006
2008
2010
2012
As of 9/13. 13-week average. Diffusion Index represents economic strength minus weakness. Gray-shaded areas indicate periods of recession. See last
slide for definition of recession. Source: ISI Group.
6
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Economy better & policy risk lower than 2011
But the fiscal fight has only just begun
US Economic Policy Uncertainty Index
260
August 2011
230
200
170
140
110
80
2008
2009
2010
2011
2012
2013
Citigroup US Economic Surprise Index
100
50
0
-50
August 2011
-100
-150
2008
2009
2010
2011
2012
2013
As of 9/13. Economic Policy Uncertainty Index measures policy-related economic uncertainty using 3 types of underlying components. One component quantifies newspaper coverage of
policy-related economic uncertainty. A second component reflects the number of federal tax code provisions set to expire in future years. The third component uses disagreement among
economic forecasters as a proxy for uncertainty. Citigroup Economic Surprise Index measures the amount that economic activity surprised or disappointed relative to analyst expectations.
Source: FactSet; Scott Baker, Nicholas Bloom and Steven J. Davis at www.PolicyUncertainty.com.
7
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Businesses “hoarding” cash
Levels not seen since WWII & reflects heightened uncertainty
Nonfinancial Corporate Business
Deposits (as % of nominal GDP)
Checkable Deposits & Currency
MMMFs
Time & Savings Deposits
10
8
6
4
2
0
1947
1957
1967
1977
As of 2Q13. MMMF represents money market mutual fund shares. Source: FactSet, Federal Reserve.
1987
1997
2007
8
Fed policy:
no taper …
for now
9
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Fed’s balance sheet has ballooned
But with velocity so low, inflation risk is minimal
QE∞ (+$85B a month)
Monetary Base ($, billions)
4,000
3,500
3,000
2,500
Fed has flooded system
2,000
1,500
1,000
500
2007
2008
2009
2010
2011
2012
2013
M2 to Monetary Base Ratio
10
9
8
But “velocity” of money
remains depressed
7
6
5
4
3
2007
2008
2009
As of 9/13. Source: FactSet, Federal Reserve.
2010
2011
2012
2013
10
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Bank deposits soaring thanks to Fed
$, billions (4-week moving average)
But lending remains subdued (record gap)
US Bank Deposits
US Bank Total Loans
10,500
9,500
8,500
7,500
6,500
5,500
4,500
3,500
2,500
1996
As of 9/13. Source: FactSet, Federal Reserve.
1998
2000
2002
2004
2006
2008
2010
2012
11
Public &
private sector
deleveraging:
a report card
12
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Incredibly shrinking deficit
Rapid improvement should help stabilize debt growth
% of nominal GDP
Federal Budget Deficit/Surplus
6
4
2
0
-2
-4
-6
-8
-10
-12
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Federal Outlays
Federal Receipts
% of nominal GDP
26
24
22
20
18
16
14
12
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
As of 8/13. Source: Department of the Treasury, FactSet, Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2013 (c) Ned Davis Research, Inc. All
rights reserved.).
13
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Debt growth down, but more to go
Debt servicing cost remains low but will rise even if rates don’t
Public Debt as % of Nominal GDP (left)
Public Debt, annual growth rate (right)
110
25
100
20
90
15
80
70
10
60
5
50
0
40
30
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
-5
Public Sector Debt Servicing Cost
20
15
10
5
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
As of 2Q13. Debt servicing cost = interest payments made on outstanding federal debt divided by total government expenditures. Source: FactSet, Federal Reserve, Ned Davis Research, Inc.
(Further distribution prohibited without prior permission. Copyright 2013 (c) Ned Davis Research, Inc. All rights reserved.), U.S. Department of Treasury.
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GDP’s strength waned as debt surged
But, it’s a “chicken-or-egg” argument as to causality
Nominal GDP (10-year % change)
180
160
140
120
100
80
60
40
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Total Credit Market Debt as % of GDP
400
350
300
250
200
150
100
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
As of 2Q13. Source: Bureau of Economic Analysis, FactSet, Federal Reserve.
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Private sector deleveraging’s come a long way
No longer causing economic drag
Household Debt as % of Disposable Personal Income
1
130
Trend including
housing bubble
110
90
70
Trend excluding
housing bubble
50
30
1952
1959
1966
1973
1980
As of 2Q13. Yellow and blue chart lines represent trend lines. Source: FactSet, Federal Reserve.
1987
1994
2001
2008
16
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Net worth takes out prior high
Housing & stock market represent 2 largest components
Household Net Worth ($, trillions)
80
70
60
50
40
30
20
10
0
1952
1962
As of 2Q13. Source: FactSet, Federal Reserve.
1972
1982
1992
2002
2012
17
US
manufacturing
& energy
renaissance:
no longer a
pipe dream
18
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Key reasons for US manufacturing renaissance
Key advantages for US
 Restrained US labor costs
 Big emerging markets wage increases
 Abundant energy/low natural gas prices
 “Made in America” bias by US consumers
 Digitization
 Labor market stability
 Rule of law
 Economic & accounting transparency
 Demographics
 Deep/liquid capital markets
 Well-developed infrastructure
 Better inventory control
 Japan energy problem
 Eurozone/China economic uncertainty
Source: ISI Group.
19
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US total cost gap narrowing significantly
Not only relative to China but to other EMs, too
Labor Cost Gap
60%
Total Landed Cost Gap
51%
50%
38%
China
40%
31%
30%
30%
23%
16%
20%
10%
0%
2005
2010
Other Emerging Markets
Labor Cost Gap
2013E
Total Landed Cost Gap
50%
40%
39%
37%
34%
30%
21%
20%
19%
18%
10%
0%
2005
2010
2013E
As of 5/24/12. Landed Cost=total cost of a product once it has arrived at buyer’s door and includes original cost of the item, all brokerage and logistics fees, complete shipping costs, customs
duties, tariffs, taxes, insurance, currency conversion, crating costs, and handling fees. Not all components are present in every shipment, but all must be considered part of the landed cost.
EM=emerging markets. Source: Supply Chain Optimization Study, The Hackett Group, 2012.
20
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It’s not just China
United States' rising cost advantage spreads
 United States will gain 2-3 million jobs; and $100b in
annual output; from higher exports and production work
shifting from China over next decade
 By around 2015, United States will have export cost
advantage of 5-25% over Germany, Italy, France, UK &
Japan in range of industries
Source: “US Manufacturing Nears the Tipping Point” by The Boston Consulting Group (BCG), March 22, 2012.
Manufacturing unit labor costs in $
1980
2011
Change
US
92
86
-6%
Germany
75
144
+92%
Canada
88
179
+103%
Source: Department of Labor.
21
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Large replacement cycle on tap
Equipment & manufacturing plants oldest on record
US Average Age of Equipment & Software
6.0
5.8
years
5.6
5.4
5.2
5.0
4.8
4.6
4.4
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
US Average Age of Manufacturing Plants
16
15
years
14
13
12
11
10
9
8
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
As of 2011. Based on historical-cost average age. Source: Bureau of Economic Analysis, ISI Group.
22
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Manufacturing workweek hit high
Should be precursor to better job growth
Average Weekly Hours-Manufacturing (3-month moving average)
42.0
41.5
41.0
40.5
40.0
39.5
39.0
38.5
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
As of 8/13. Source: Department of Labor, FactSet.
23
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Manufacturing adding most to GDP
While government spending brings up rear
US 2012 Contribution to % Change in Real GDP
Governm ent
Agriculture, forestry, fishing, & hunting
Other services
Educational services
Utilities
Arts, entertainm ent, & recreation
Health care & social assistance
Transportation & w arehousing
Adm inistrative & w aste services
Managem ent of com panies
Mining
Professional, scientific, & technical services
Accom m odation & food services
Construction
Real estate, rental, & leasing
Nondurable-goods m anufacturing
Retail Trade
Inform ation
Wholesale Trade
Finance & insurance
Durable-goods m anufacturing
-0.10
As of 12/12. Source: Bureau of Economic Analysis.
0.00
0.10
0.20
0.30
0.40
0.50
0.60
24
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US manufacturing/GDP comeback
First “triple” in postwar era
US Manufacturing as % of Nominal GDP (y/y point change)
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
-2.0
1948
1958
1968
1978
1988
1998
2008
As of 12/12. Source: Bureau of Economic Analysis, FactSet, Ned Davis Research, Inc. (Further distribution prohibited without prior permission. Copyright 2013 (c) Ned Davis Research, Inc. All
rights reserved.).
25
Housing:
boosting
economy,
confidence &
jobs
26
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Housing turning up as % of GDP
Long path back to “normal” but trend will help economy
Residential Investment
Average
% of nominal GDP
7
6
5
4
3
2
1966 1971 1976 1981 1986 1991 1996 2001 2006 2011
As of 2Q13. Gray-shaded areas indicate periods of recession. See last slide for definition of recession. Source: Bureau of Economic Analysis, FactSet.
27
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New home prices at all-time high!
Reflecting limited new building/record-low inventories
Median Single-Family Sales
Prices ($, thousands)
New Home Prices
Existing Home Prices
300
250
200
150
100
50
1980
1984
1988
1992
1996
As of 8/13. 12-month moving average. Source: FactSet, National Association of Realtors, US Census Bureau.
2000
2004
2008
2012
28
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Housing inventory off historic lows
Explains jump in prices
% of working-age population
New & Existing Single-Family Homes for Sale
Average
2.0
1.8
1.6
1.4
1.2
1.0
0.8
0.6
1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012
As of 8/13. Source: FactSet, National Association of Realtors, Organization for Economic Cooperation and Development (OECD), US Census Bureau.
29
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Impact of spike in mortgage rates
Biggest weight on refi; not as much on purchases
30-Year Fixed Mortgage Rate
9
8
7
6
5
4
3
2000
2002
2004
2006
MBA Refinance Index (left)
2008
2010
2012
MBA Purchase Index (right)
10,000
550
8,000
450
6,000
350
4,000
250
2,000
0
2000
150
2002
2004
2006
2008
2010
2012
As of 9/13. The Refinance Index covers all mortgage applications to refinance an existing mortgage. The Purchase Index includes all mortgages applications for the purchase of a single-family
home. Source: FactSet, Mortgage Bankers Association (MBA), Ned Davis Research, Inc. (Further distribution prohibited without prior permission. Copyright 2013 (c) Ned Davis Research, Inc.
All rights reserved.).
30
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Housing affordability falling but still high
Rising mortgage rates have been culprit
a
b
Housing Affordability Index
220
200
180
160
140
120
100
80
60
1981
1985
a
1989
b
1993
1997
2001
2005
2009
2013
2009
2013
Ratio of Home Prices to DPI
115
110
105
100
95
90
85
80
75
1981
1985
1989
1993
1997
2001
2005
Affordability Index as of 7/13. Ratio data as of 2Q13. DPI=disposable personal income. Gray-shaded areas indicate periods of recession. See last slide for definition of Affordability Index and
recession. Source: FactSet, Federal Finance Housing Board, High Frequency Economics (HFE), National Association of Realtors.
31
“Real” mortgage rates remain deeply
negative
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As long as prices continue to rise, higher rates won’t bite much
Real Mortgage Rates for Existing Single-Family Homes
25
2
20
15
10
5
0
-5
-10
1
-15
1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011
3
1) 6.1% minus 16.9% = (10.8%)
2) 5.1% minus (16.7%) = 21.8%
3) 4.3% minus 14.4% = (10.1%)
As of 8/13. Real Mortgage Rate represents 30-year fixed mortgage rate minus y/y % change in median sales price. Gray-shaded areas indicate periods of recession. See last slide for definition of
recession. Source: FactSet, Federal Reserve, National Association of Realtors.
32
Stock & bond
markets:
valuation/
sentiment/
rising yields
33
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Current bull still sub-average
S&P 500 bull markets
Start date
End date
Duration
(months)
6/1/1932
3/10/1937
57
324%
4/28/1942
5/29/1946
49
158%
6/13/1949
8/2/1956
86
267%
10/22/1957
12/12/1961
50
86%
6/26/1962
2/9/1966
43
80%
10/7/1966
11/29/1968
26
48%
5/26/1970
1/11/1973
32
74%
10/3/1974
11/28/1980
74
126%
8/12/1982
8/25/1987
60
229%
12/4/1987
7/16/1990
31
65%
10/11/1990
3/24/2000
113
417%
10/9/2002
10/9/2007
60
102%
57
165%
55
149%
Average
3/9/2009
*As of 9/30/13. Source: Strategas Research Partners LLC.
?*
Percent change
34
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Market highs after long drought…now what?
New all-time highs in Dow Jones Industrial Average (1900-2013)
DJIA performance (%)
Date of new
high
Calendar
days since
prior high
One
month
Three
month
Six
month
One
year
Maximum
drawdown
Maximum
gain
3/24/1905
1,375
2.1
-4.4
3.3
19.6
-10.0
29.9
9/28/1916
3,904
1.7
-8.8
-6.2
-18.7
-19.4
9.3
7/9/1919
959
-7.8
2.8
-2.6
-14.5
-20.9
8.3
12/31/1924
1,884
2.5
-2.0
9.3
30.0
-4.6
32.3
11/23/1954
9,211
3.8
7.5
9.8
26.1
0.0
27.4
9/15/1958
889
2.4
7.8
16.1
20.8
-0.2
29.6
11/10/1972
2,465
3.8
-1.6
-6.8
-8.7
-14.4
5.7
11/3/1982
3,582
-3.2
-0.3
13.8
14.3
-7.1
20.6
10/3/2006
2,453
2.5
6.3
6.7
19.2
0.0
20.1
3/5/2013
1,973
2.2
5.0
4.8
?
?
?
Average
1.0
1.2
4.8
9.8
-8.5
20.3
% of time positive
80
50
70
67
All period average
0.5
1.7
3.4
7.1
% of time positive
58
60
63
65
Table highlights each of the prior periods where Dow Jones Industrial Average (DJIA) went two or more years without closing at new all-time high. Source: Bespoke Investment Group, LLC (B.I.G.).
35
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US outperformance of EM since ’09 low
Beginning of secular shift?
S&P 500 Relative to MSCI Emerging Markets Index
4.5
3.5
2.5
1.5
0.5
1988
1991
1994
1997
2000
2003
As of 9/30/13. EM=emerging markets. Source: FactSet, Morgan Stanley Capital International (MSCI), Standard & Poor’s.
2006
2009
2012
36
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New secular bull market relative to gold?
3rd consecutive 13-year gold bull likely over
S&P 500 Total Return
Gold
$100,000
$10,000
$1,000
$100
$10
$1
1912 1922 1932 1942 1952 1962 1972 1982 1992 2002 2012
As of 8/13. Source: Bloomberg, Windhaven Investment Management, Inc.
37
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Stocks & commodities de-linking
Commodity “super cycle” likely topped in 2011
S&P 500 Index (left)
CRB Index (right)
1,800
500
1,600
450
1,400
400
1,200
350
1,000
300
800
250
600
2003
200
2005
2007
2009
2011
As of 9/30/13. CRB (Commodity Research Bureau) Index based on the Thomson Reuters/Jefferies CRB Commodity Index. Source: FactSet.
2013
38
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Stocks & commodities typically divergent
Reflects hit to economy/stocks/valuation when inflation’s high
*
*
*Most recent shaded areas represent Liz Ann Sonders’ view of respective bull markets.
39
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Stocks & dollar reconnecting
Dollar stronger for “right” reasons…better relative growth
S&P 500 (left)
US Dollar Index (right)
1,800
105
1,600
100
95
1,400
90
1,200
85
1,000
80
800
75
600
2003
70
As of 9/30/13. Source: FactSet.
2005
2007
2009
2011
2013
40
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Comparing stock & dollar markets
History shows equity returns were higher when dollar was rising
Dollar
bull/bear
$ bull
S&P 500 performance during dollar bull & bear markets
Calendar US dollar index
S&P 500
Dates
days
% change
% change
10/30/1978-2/25/1985
2,310
100.7%
88.5%
$ bear
2/25/1985-12/31/1987
1,039
-48.2%
37.9%
$ bull
12/31/1987-6/14/1989
531
23.7%
31.1%
$ bear
6/14/1989-2/11/1991
607
-23.8%
13.8%
$ bull
2/11/1991-7/5/2001
3,797
50.2%
230.8%
$ bear
7/5/2001-4/22/2008
2,483
-41.0%
12.9%
$ bull
4/22/2008-3/5/2009
317
24.9%
-50.4%
$ bear
3/5/2009-11/25/2009
265
-16.7%
62.7%
$ bull
11/25/2009-6/7/2010
194
19.0%
-5.4%
$ bear
6/7/2010-4/29/2011
326
-17.5%
29.8%
Average dollar bull market
43.7%
58.9%
Average dollar bear market
-29.4%
31.4%
10.0%
23.3%
Recent $ rally
*As of 9/30/13. Source: FactSet.
4/29/2011-?*
885
41
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On forward earnings, stocks appear undervalued
Gives market breathing room in face of slower earnings growth
S&P 500 Forward P/E
35
30
25
20
15
Median = 16.5x
10
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Current S&P 500 forward P/E @ 14.7
As of 9/13. Current P/E based on estimated 3Q13 EPS. P/Es are based on forward 12-month operating earnings. Source: FactSet, Standard & Poor’s.
42
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Imminent acceleration in earnings coming?
High correlation between earnings & ISM new orders
S&P 500 Operating Earnings, y/y % change (left)
ISM New Orders Index (right)
45
*
30
80
70
15
60
0
50
-15
40
-30
30
-45
1990
20
1993
1996
1999
2002
2005
2008
2011
As of 8/13. *Earnings truncated at 40% in 2010. Data represents 12-month earnings per share. Source: BCA Research Inc., FactSet, ISM (Institute for Supply Management), Standard & Poor’s.
43
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Profit margins peaking?
Not necessarily a problem for stocks
Margin peaks & stock market performance
Date when profit
margins peaked
S&P 500 nominal total return
S&P 500 real total return
Year
Quarter
1-year after
2-years after
1-year after
2-years after
1950
4
24%
46%
17%
37%
1955
1
38%
31%
37%
26%
1959
2
1%
18%
-1%
15%
1966
1
5%
8%
2%
1%
1973
1
-13%
-19%
-21%
-33%
1977
3
12%
26%
3%
4%
1984
2
31%
78%
26%
68%
1988
4
32%
28%
26%
15%
1997
3
9%
39%
7%
34%
2006
3
16%
-9%
13%
-16%
Mean
15%
25%
11%
15%
Median
14%
27%
10%
15%
1950-2012. Profit Margins defined as total pre-tax corporate profits relative to corporate GDP. Source: BCA Research Inc.
44
Investors had banished stocks in favor of
bonds
(1013-6769)
Bond funds now experiencing record outflows
Net New Cash Flow Cumulative Change ($, billions)
Domestic Equity Mutual Funds
1,200
800
400
0
-400
2009
2010
2011
2012
2013
Total Bond Mutual Funds (right)
6
20
4
10
2
0
0
-10
-2
-20
-4
-6
1/13
2/13
3/13
4/13
5/13
6/13
As of 9/13. Bottom chart based on estimated weekly cash flows. Source: Investment Company Institute (ICI).
7/13
8/13
-30
9/13
Net New Cash Flow ($, billions)
-800
2008
Domestic Equity Mutual Funds (left)
Net New Cash Flow ($, billions)
Total Bond Mutual Funds
45
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Pension funds have de-risked
Pension Funding Asset Allocation
Fixed income exposure now above equity exposure
Equities
Fixed Income
65%
60%
55%
50%
45%
40%
35%
30%
25%
2005
2006
2007
2008
2009
2010
2011
2012
As of 3/13. Data covers 100 US public companies with the largest defined benefit pension plan assets for which a 2012 annual report was released by 3/7/13. Source: Milliman 2013 Pension
Funding Study.
46
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Endowments’ equity exposure way down
Alternative strategies biggest beneficiary
Endowments asset allocation (dollar-weighted average)
Year
Equities
Fixed
income
Alternative
strategies
Cash/
other
2002
50%
23%
24%
2%
2003
49%
21%
27%
2%
2004
51%
17%
28%
4%
2005
48%
17%
32%
3%
2006
48%
15%
35%
2%
2007
47%
13%
37%
2%
2008
40%
13%
46%
1%
2009
32%
13%
51%
4%
2010
31%
12%
52%
5%
2011
33%
10%
53%
4%
2012
31%
11%
54%
4%
Source: NACUBO (National Association of College and University Business Officers)-Commonfund Study of Endowments (2009-2012), NACUBO Endowment Study (2002-2008), Strategas
Research Partners LLC.
47
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Investor confidence moves with market
Sentiment now in best zone for stocks
NDR Crowd Sentiment Poll
80
Extreme Optimism (Bearish for Market)
70
60
50
40
30
Extreme Pessimism (Bullish for Market)
20
2007
2008
2009
2010
2011
2012
2013
12/1/1995-9/24/2013
We are here
NDR Crowd Sentiment Poll
S&P 500 annualized gain
>66
-7.6%
57-66 from above
-3.1%
57-66 from below
16.7%
< 57
10.5%
As of 9/24/13. See last slide for description of Crowd Sentiment Poll. Source: Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior
permission. Copyright 2013 (c) Ned Davis Research, Inc. All rights reserved.).
48
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Market’s emotional roller coaster
Maintaining discipline = key to long-term success
Euphoria
Exhilaration
Bull
Market
Ends
Uneasiness
Enthusiasm
Denial
Optimism
Optimism
Pessimism
Panic
Bear
Market
Ends
Capitulation
Relief
Hope
Despair
49
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Disclosures/definitions
Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or
personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an
investment strategy for his or her own particular situation before making any investment decision. We believe the information obtained from third-party
sources to be reliable, but neither Schwab nor its affiliates guarantee its accuracy, timeliness, or completeness. The views, opinions and estimates herein
are as of the date of the material and are subject to change without notice at any time in reaction to shifting market conditions. Past performance is no
guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance. Examples provided are for illustrative
purposes only and not intended to be reflective of results you should expect to attain.
Index Definitions
Indexes are unmanaged, do not incur management fees, costs and expenses (or "transaction fees or other related expenses"), and cannot be invested in
directly.
The Dow Jones Industrial Average (DJIA, “The Dow”) is a price-weighted average of 30 actively traded blue chip stocks, primarily industrials and is
the oldest and most widely quoted of all the market indicators.
The IntercontinentalExchange (ICE) U.S. Dollar Index is an index of the of the United States dollar relative to a basket of foreign currencies, and is a
weighted geometric mean of the dollar’s compared to the Euro (EUR), Japanese yen (JPY), Pound sterling (GBP), Canadian dollar (CAD), Swedish
krona (SEK) and Swiss franc (CHF) relative to March 1973.
The Morgan Stanley Capital International (MSCI) Emerging Markets (EM) Index is a free float-adjusted market capitalization index that is designed to
measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country
indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland,
Russia, South Africa, Taiwan, Thailand, and Turkey.
The National Association of Realtors (NAR) Housing Affordability Index (HAI) measures whether or not a typical family could qualify for a mortgage
loan on a typical home. A value of 100 means a family with the median income has exactly enough income to qualify for a mortgage on a median-priced
home. An index above 100 signifies that family earning the median income has more than enough income to qualify for a mortgage loan on a medianpriced home, assuming a 20 percent down payment.
The S&P 500 Index is a capitalization-weighted index of 500 stocks from a broad range of industries. The component stocks are weighted according to
the total market value of their outstanding shares.
The Thomson Reuters/Jefferies CRB (Commodity Research Bureau) Commodity Index is a global commodity index that tracks the price movement
of commodity futures as a whole.
Terms
AAII (American Association of Individual Investors) Investor Sentiment Survey measures the percentage of individual investors who are bullish,
Ned Davis Research (NDR) Crowd Sentiment Poll - Shows perspective on a composite sentiment indicator designed to highlight short- to
intermediate-term swings in investor psychology. It's based on seven different individual sentiment indicators in order to represent the psychology of a
broad array of investors.
Recession - As per National Bureau of Economic Research (NBER), a recession is a significant decline in economic activity spread across the
economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.
©2013 Charles Schwab & Co., Inc. All rights reserved. Member SIPC
50
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New highs…then vs. now: bad stuff
3/24/2000
10/9/2007
9/18/2013
S&P 500® index
1,527
1,565
1,726
Budget deficit (12-month sum)
$138b
$169b
$680b
Fed balance sheet
$556b
$858b
$3,672b
Gross federal debt
$5,773b
$9,007b
$16,738b
Debt as % of nominal GDP
58%
62%
100%
NYSE average daily volume (millions of shares)
1,124
1,320
750
Consumer confidence
137.1
95.2
79.7
5.7
7.2
11.3
Unemployment rate
4.0%
4.7%
7.3%
S&P rating of US debt
AAA
AAA
AA+
Americans unemployed (millions)
Source: Bloomberg, FactSet, Federal Reserve, Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2013 (c) Ned Davis Research, Inc. All rights
reserved.), Standard & Poor’s.
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New highs…then vs. now: good stuff
3/24/2000
10/9/2007
9/18/2013
1,527
1,565
1,726
S&P 500 operating earnings
$54
$89
$102e
S&P 500 P/E
28.3
17.6
16.9
S&P dividends per share
$17
$28
$34
AAII investor sentiment survey – bullish
66%
55%
45%
10-year Treasury yield
6.2%
4.7%
2.7%
-44
52
234
% of S&P 500 above 200-day moving average
NA
60%
85%
% of S&P 500 with 50-day moving average above
200-day moving average
NA
43%
82%
2.4%
2.2%
1.8%
$6,508b
$13,644b
$12,971b
S&P 500 index
10-year minus 2-year Treasury yield spread
(basis points)
Core CPI (y/y % change)
Household debt
See last slide for description of AAII (American Association of Individual Investors) Sentiment Survey. Source: Bloomberg, FactSet, Federal Reserve, Ned Davis Research (NDR), Inc. (Further
distribution prohibited without prior permission. Copyright 2013 (c) Ned Davis Research, Inc. All rights reserved.), Standard & Poor’s.
52
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Bond yields settle down after no QE taper
Renewed uncertainty about QE taper timing
10-Year Treasury Yield
16
14
12
10
8
6
4
2
0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
10-Year Treasury Yield
3.0
2.8
2.6
2.4
2.2
2.0
1.8
1.6
1.4
Jul-12
As of 9/13. Source: FactSet, The Leuthold Group.
Sep-12 Nov-12
Jan-13 Mar-13 May-13
Jul-13
Sep-13
53
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When might unemployment hit 6.5%?
Fed’s unemployment rate threshold puts payrolls in spotlight
Mapping payrolls to the 10-year Treasury
Monthly payroll
change (000s)
Fed Funds
(“lift-off” date)
10Y Treasury yield
(%, end of 2013 est.)
230
Mar 2014
3.9%
220
Jun 2014
3.8%
210
Sep 2014
3.6%
200
Dec 2014
3.4%
190
Jun 2015
2.8%
180
Sep 2015
2.5%
170
Jun 2016
1.8%
160
Jun 2017
1.4%
150
Mar 2018
1.1%
As of 2/5/13. Source: BCA Research Inc.
54
Current bull market: rising yields = rising
stocks
(1013-6769)
S&P 500 performance during periods of rising and falling yields
10-year Treasury yield
Rising/
falling
Begin
End
Start
Finish
Change
Days
S&P 500
change
Rising
3/9/2009
4/5/2010
2.89
4.01
38.8%
392
75.5%
Falling
4/5/2010
10/8/2010
4.01
2.41
-39.9%
186
-1.9%
Rising
10/8/2010
2/8/2011
2.41
3.75
55.6%
123
13.7%
Falling
2/8/2011
9/22/2011
3.75
1.72
-54.1%
226
-14.7%
Rising
9/22/2011
10/27/2011
1.72
2.42
40.7%
35
13.7%
Falling
10/27/2011
1/31/2012
2.42
1.83
-24.4%
96
2.2%
Rising
1/31/2012
3/19/2012
1.83
2.39
30.6%
48
7.4%
Falling
3/19/2012
7/25/2012
2.39
1.43
-40.2%
128
-5.1%
Rising
7/25/2012
3/11/2013
1.43
2.07
44.8%
229
16.3%
Falling
3/11/2013
5/2/2013
2.07
1.66
-19.8%
52
2.7%
Rising
5/2/2013
9/30/2013
1.66
2.64
59.0%
151
5.3%
Average rising yields
% of time positive
Average falling yields
% of time positive
As of 9/30/13. Source: Bespoke Investment Group, LLC (B.I.G.) Federal Reserve, FactSet.
22.0%
100
-3.4%
40
55
Economic & market performance during rising
rates
(1013-6769)
Growth tends to be above-average, at least for a while
Economic & market performance during rising interest rate periods
(based on monthly 10-year Treasury yield)
% Gain per annum
Trough
Apr 1954
Peak
Oct 1957
10Y Treasury
yield begin
2.3%
10Y Treasury
yield end
4.0%
S&P 500
16.7%
May 1958
Jan 1960
2.9%
4.7%
22.5%
11.6%
3.9%
May 1961
Aug 1966
3.7%
5.2%
7.0%
4.9%
3.5%
Mar 1967
May 1970
4.5%
7.9%
-1.9%
3.0%
2.6%
Mar 1971
Sep 1975
5.7%
8.4%
-0.1%
2.2%
1.9%
Dec 1976
Mar 1980
6.9%
12.8%
5.1%
3.6%
3.9%
Jun 1980
Sep 1981
9.8%
15.3%
7.6%
2.6%
1.2%
Jan 1987
Mar 1989
7.1%
9.4%
8.3%
3.7%
3.1%
Oct 1993
Nov 1994
5.3%
8.0%
1.8%
4.4%
3.4%
Oct 1998
Jan 2000
4.5%
6.7%
17.0%
3.8%
2.5%
Jun 2003
May 2006
3.3%
5.1%
11.4%
2.4%
1.6%
Median
4.5%
7.9%
7.6
3.6%
2.6%
Mean
5.1%
8.0%
8.7%
4.1%
2.7%
11.2%
2.5%
1.7%
Gain per annum over entire history
Coincident index Nonfarm payrolls
3.3%
2.0%
Table highlights periods between local troughs and peaks in the 10-year Treasury yield around Fed tightening cycles. Source: Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright
2013 (c) Ned Davis Research, Inc. All rights reserved.).
56
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Longer-term valuation stretched
But largest equity inflows have come when P/E was around 20
S&P 500 P/E (5-year normalized)
40
35
30
Median = 17.6x
25
20
15
10
5
1946
1954
1962
1970
1978
1986
1994
2002
2010
Current S&P 500 normalized P/E @ 21.1
As of 9/13. The Leuthold Group calculates normalized earnings using a 5-year average of reported earnings (18 quarters of historical results combined with 2 quarters of future estimates). To
adjust for legitimate write-offs, the mid point between reported earnings and operating earnings is used. Source: The Leuthold Group.
57
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Moderate inflation supports higher valuations
Inflation in one of valuation’s sweet spots
1946-8/2013
We are here
Inflation
Average P/E
Highest P/E
Lowest P/E
< 0%
12.6
17.1
9.3
0 – 1%
14.5
22.5
9.2
1–2%
19.8
32.6
9.2
2 – 3%
20.5
35.1
9.7
3 – 4%
18.7
34.4
9.7
4 – 5%
16.8
22.4
9.6
5 – 6%
15.9
19.8
7.4
6 – 7%
12.2
18.1
7.7
>7%
11.9
19.1
7.9
Current S&P 500 normalized P/E @ 21.1
1946-8/13. Current P/E as of 9/13. The Leuthold Group calculates normalized earnings using a 5-year average of reported earnings (18 quarters of historical results combined with 2 quarters of
future estimates). To adjust for legitimate write-offs, the mid point between reported earnings and operating earnings is used. Inflation is y/y % change based on CPI. Source: Bureau of Labor
Statistics, FactSet, The Leuthold Group.
58
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Valuation expansion could continue
Historically, much higher rates before valuation suffered
S&P 500 P/E (5-year normalized)
25
20
22.7
20.1
18.4
14.7
15
10
We are here
5
0
1.4%-3.0%
3.0%-4.5%
4.5%-6.5%
> 6.5%
10-Year Treasury Yield
Current S&P 500 normalized P/E @ 21.1
1962-8/13. Current P/E as of 9/13. The Leuthold Group calculates normalized earnings using a 5-year average of reported earnings (18 quarters of historical results combined with 2 quarters of
future estimates). To adjust for legitimate write-offs, the mid point between reported earnings and operating earnings is used. Source: FactSet, Federal Reserve, The Leuthold Group.
59