3Q/2018 Multi-Asset Commentary | 1

3Q/2018 Multi-Asset Commentary

OVERVIEW• Global monetary conditions may be tightening a bit faster than previously thought, as the European Central Bank dials back

liquidity and the Federal Reserve ponders the possibility of four interest rate hikes in 2018. Share prices are vulnerable, givenhigh valuations and rosy earnings expectations.

• An escalating tit-for-tat on trade, rising commodity prices and a strengthening U.S. dollar present headwinds to global GDPgrowth. In our view, however, the degree to which the growth pace outside the U.S. may have fallen off could be a bit exaggerated.

• Trade-related uncertainties prompted us to fine-tune some portfolio allocations: We trimmed our overweight to emergingmarkets, reduced our underweight to U.S. small caps and shifted commodities from neutral to slight underweight.

• Our underweight to fixed income contributed to relative performance, as did security selection within fixed income. Detractorsincluded our underweight to U.S. equities and overweights to non-U.S. developed and emerging markets.

2Q/18 MARKETS RECAP

Equities — U.S. small cap stocks outpaced other equity classes in the first half of 2018, in large part due to their relative insulation from global trade turmoil that sapped strength from non-U.S. developed and emerging markets. European shares were also hurt by a GDP growth slowdown.

Fixed Income — The Treasury yield curve continued to flatten in 2Q as Fed rate hikes pushed up the short end and growth worries pressed down at the long end. Credit spreads widened a bit, and EM debt took a hit from trade concerns and a stronger U.S. dollar.

Alternatives — Commodities fared well in 2Q, as a double-digit upward move for oil more than offset a weak quarter for gold and a mixed showing for key industrial metals. Real estate also turned in a strong performance on GDP growth pick-up and lower 10-year Treasury yields.

ASSET CLASS CHANGE UNDERWEIGHT NEUTRAL OVERWEIGHT

Equities — ●

US Large Cap — ●

US Small Cap ▲ ●

International Developed — ●

Emerging Markets ▼ ●

Fixed Income — ●

Investment Grade — ●

High Yield — ●

Alternatives ▲ ●

Commodities ▼ ●

REITs ▲ ●

■ Full Underweight ■ Partial Underweight ■ Neutral■ Partial Overweight ■ Full Overweight

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LOOKING AHEADAs the Treasury yield curve gets flatter, the chatter about a possible inversion gets louder. That in turn adds to worries that recession could be coming. Seven interest rate hikes since late 2015 by the Federal Reserve has pushed up the short end of the curve (Figure 1), but the Fed doesn’t control the longer end of the curve. Market worries about stock volatility, a trade war and signs of slowing global GDP growth (especially in Europe) have fueled a flight-to-safety rally for longer-dated Treasuries that is pushing down yields.

We’re not forecasting a recession, but we are mindful that the Fed has a difficult task in trying to control inflation and at the same time not knock the legs out from under economic growth. Even if the Fed executes flawlessly, we could still see a GDP slowdown in the not-distant future that could have an impact on equity prices, given high valuations and lofty earnings expectations. For the rest of 2018, however, we think it’s more likely that the potent combination of double-digit earnings growth, corporate tax reform and an upswing in share buybacks provides support for stocks.

Trade uncertainties Challenging the structure of global trade was a key promise in President Trump’s 2016 campaign, so it should come as no surprise that we now have $200 billion-plus in imports (mostly from China) in the tariff crosshairs, and that our trade partners are vowing to retaliate. So far the U.S. stock market has held up much better than overseas markets as the tit-for-tat has escalated — emerging markets have taken a hit as the issues involving trade come at the same time that global monetary conditions are tightening. The potential impact on EM over the longer term is less clear, especially for developing Asia. The total value of China’s exports to the U.S. represents only 3% of its GDP, and trade between EM nations has grown nearly fourfold since 1990 (Figure 3).

Global growth intactWhen the synchronized global growth story started showing some cracks this year, non-U.S. equities bore the brunt. For emerging markets (-8% in 2Q), trade tensions, higher commodity prices and a strengthening U.S. dollar added to the woes. In our view, just how much the growth pace outside the U.S. has fallen off may be a bit exaggerated. Figure 2 shows there’s still a positive trend in our global sentiment gauge, a weighted measure of that includes the U.S., China and the eurozone. A slight dip in early 2018 in Europe (in part due to bad weather and capacity constraints) appears to be mitigating, though the upside of a weaker euro (-6% vs. USD since April) could be more than offset by the downside of further trade impediments.

Source: U.S. Department of the Treasury

Economies: United States, China, Eurozone | Source: FactSet and USAA

FIGURE 1

RATE POLICY FLATTENS CURVE BY PUSHING UP SHORT ENDTREASURY YIELDS, 2Q 2018 VS.

START OF FED TIGHTENING

■ 6/29/18 ■ 12/31/15

FIGURE 2

MAJOR ECONOMIES MAINTAIN GROWTH OUTLOOK

USAA GLOBAL ECONOMIC SENTIMENT INDICATOR (NEUTRAL = 100)

0

3.5

2.0

2.5

3.0

1.0

1.5

0.5

1 Mo. 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr 30 Yr3 Mo. 6 Mo.

75

120

110

115

95

100

105

85

90

80

2008 2010 2012 2014 2016 2018

3Q/2018 Multi-Asset Commentary | 3

Late cycle signs U.S. economic expansion is now in a 10th year, as is the current bull market for U.S. equities — for both, that’s long in the tooth by historic standards. Other late-inning markers are also being seen, including a decade low in joblessness, peaking profit growth, and the growth-eroding tandem of rising inflation and higher interest rates. While overseas markets are lagging the U.S. now, we believe they offer better investment opportunities, in part because they look to be earlier in their market and economic cycles. Our asset-allocation portfolios are positioned consistent with this outlook, with holdings of U.S. equities being below the benchmark weight and non-U.S. developed and emerging markets above the benchmark weights.

KEY THEMES Overall, we are neutral risk. In equities, we are positioned with a larger than normal tilt toward value over growth globally. We think value stocks are much cheaper than their historical average, and thus could provide some downside protection. Overweights to emerging market and non-U.S. developed market equities offset an underweight to U.S. large caps and small caps.

▲ Value U.S. value stocks have struggled to catch a bid in 2018, as investors have continued to eagerly pile in high-growth names in the technology and consumer discretionary sectors. Vivid case in point: One of the most prominent tech stocks doubled in price in the first half of 2018, in the process driving up its P/E ratio to over 250x. Overseas, growth has also outperformed, though not as dramatically. We see growth’s long winning streak as an opportunity for value, given its more appealing fundamentals. Sector-wise, energy stands to benefit from higher oil prices and financials from rising short-term interest rates.

▲ Emerging MarketsGlobal trade uncertainties and a stronger U.S. dollar have thrown a powerful one-two punch at emerging markets in 2018. These short-term challenges do little to dim our belief that EM are well-positioned to outperform other equity markets over the longer term. They are cheap on a relative valuation basis, with high earnings growth and look to be at an earlier point in the economic cycle. Another key positive is that EM are less dependent on developed markets than in the past (Figure 3) — trade between EM nations is approaching a quarter of the global total, up from single digits in the 1990s.

▲ JapanWe see worthy long-term opportunities in Japan and thus maintain an overweight in our asset-allocation portfolios. Given their export-oriented focus, Japanese stocks have been hurt recently by tariff threats and by a strengthening yen as Japanese investors have pulled back money from overseas. At home, however, there are trends that bode well for the future — fundamental valuations are improving and the Bank of Japan is maintaining loose monetary policy, while a corporate tax cut has led to higher wages and more capital spending. These policy actions have nudged inflation closer to desired levels.

Trade between emerging and developed markets can be EM to DM or DM to EM.Source: IMF Direction of Trade Statistics

FIGURE 3

EM PLAYS BIGGER ROLE IN GLOBAL COMMERCE

TRADE SOURCE/DESTINATION, 1990 VS. 2017

■ EM/EM ■ EM/DM ■ DM/DM

0%

90%

70%

80%

40%

50%

60%

20%

30%

10%

20171990

6%

18%

77%

29%

49%

22%

3Q/2018 Multi-Asset Commentary | 4

USAA GLOBAL MULTI-ASSETS TEAMThe USAA Global Multi-Assets team manages more than $11 billion* in assets invested in Target Retirement funds, the Cornerstone series of target-risk funds, and several outcome-oriented funds.

Our asset allocation views and portfolio positioning follow a rigorous and disciplined process that integrates:

• Quantitative analysis that empirically captures long-termasset class relationships and seeks to identify relative valueopportunities

• Qualitative inputs that include macroeconomic thematic views,interest rate policy and business cycle insights, as well as tacticalmarket opportunities

• Rigorous risk management throughout the investment process

Wasif LatifHead of USAA Global Multi-Assets

Lance Humphrey, CFAPortfolio Manager

Julius Barnes, CFASenior Analyst

Lela Dunlap, CFAAnalyst

Raymond Fu, CFAAnalyst

Our fundamental beliefs• Diversification matters

• Active management adds value

• Value beats growth

• Credit outperforms sovereigns

We take the long view• Look through noise and short-term returns

• Willing to deviate from consensus

We put shareholders first• Seek to compensate investors for risks taken

• Continuously manage portfolio risk

OUR PHILOSOPHY

*AUM as of June 30th, 2018

3Q/2018 Multi-Asset Commentary | 5

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