market q1 2014 quarterly review - bmo harris bank · the following review of the first quarter...

Plenty to talk about in the first quarter of 2014 including: Janet Yellen stepping in as chair of the Federal Reserve (Fed); weather, weather everywhere, and, over the last several weeks of the quarter, the geopolitical upsets of Ukraine/Russia rattling the world, as well.

Janet Yellen, as the quote suggests, has almost seamlessly assumed the role as Fed chair and continued the language and actions contained in the Ben Bernanke playbook. After the initial $10 billion reduction in the amount of quantitative easing (QE) in December (announced by Bernanke), she followed through with two more rounds of QE reduction and harnessed language in her first testimony before Congress that closely paralled the tone of the prior Fed chair. Obviously this path of reducing the amount of quantitative easing is still data dependent, but the data will need to be quite troubling to change this direction.

The one big caveat that came with Yellen’s testimony was that much of the weaker economic data we saw in January and February wore a great big asterisk with it, which was weather related. Truly, weather conditions were not just locally or regionally bad, they were nationally bad. The snow and cold in all the usual places were unusually harsh, touching the Midwest, the Southeast and the eastern seaboard, not to mention the drought and fire conditions hitting California. As a result, consumers spent less, employers hired less, auto companies sold less, etc. Hopefully, the next month or two will yield more normal conditions and better results to boot.

In February, the global markets confronted a new concern: Russia’s grab of Crimea in the eastern Ukraine. The resulting geopolitical upset of that situation, which continues unresolved, created a downdraft for stock prices from the U.S. to Europe and beyond— and this on the heels of geopolitical upsets in Turkey, Indonesia, Argentina and South Africa earlier in the year.

In spite of all the geopolitics, a new leader of the U.S. central bank and some weaker U.S. economic data (that may have been impacted by weather), the U.S. equity markets held their gains of 2013 and the S&P 500® actually eked out a positive return of just 1.8% for the quarter. Other developed world markets (EAFE) rose a fractional 0.7%, while the emerging markets were hit, again, and fell a modest 0.4% for the quarter.

The following review of the first quarter provides a broader discussion on these and other global developments.

Neither snow nor cold...could deter the Fed

Table of contents

2 } U.S. overview

6 } U.S. equities

8 } U.S. fixed income

10 } Developed world/EAFE

12 } China

13 } Emerging markets

14 } Themes, headwinds and tailwinds

15 } Scorecard

16 } Global returns

“A number of data releases have pointed to softer spending than many analysts have expected. Part of that softness may reflect adverse weather conditions, but at this point it’s difficult to discern exactly how much. [We] will be attentive to signals that indicate whether the recovery is progressing in line with our earlier expectations.”

— Janet Yellen, Chair of Federal Reserve, testimony to the Senate Banking Committee on February 27, 2014

Q1 2014

Market Perspectives

Quarterly Review

Mixed housing data

6/30/13 9/30/13 12/31/13 as of 3/31/14

30-year fixed rate (%) 4.4 4.3 4.5 4.4

S&P Homebuilding Index 455 431 491 477

Case Shiller Home Price Index Y/Y (%) 12.0 13.3 13.4 13.2

New home sales m/m (%) 4.9 3.9 -1.6 -3.3

Pending home sales m/m (%) 1.1 -2.9 -5.8 0.1

Existing home sales m/m (%) 0.2 -1.3 0.8 -0.4

Private building permits m/m (%) -6.8 5.2 -2.6 7.7

NAHB6 Market Index 51 57 57 47

2

U.S. overview: weather, jobs, trade and geopolitics

Housing has been a positive headline for the last one to two years; prices rose and distressed sales declined, etc. Again, the weather likely weighed on housing in the first quarter, and certainly there are concerns about the potential for mortgage rates to rise, but it hasn’t yet occurred. The data on housing is a mix: mortgage rates held steady in the last few months, new home sales were better and overall housing prices were okay. So housing may be slowing its growth rate, but not too dramatically.

• Data is mixed, still inconclusive but not reversing.

• Mortgage rates remain exceptionally low on a historical basis, and affordability remains high.

U.S. weather conditions were so severe and widespread that weaker results from metrics on job creation to auto sales all came with a footnote. Hopefully, as winter turns to spring, these metrics will bounce back.

Weather impacts included:

• Over 600k missed work in February due to bad weather

• Major cities shut down (e.g., Atlanta) and closed schools

• Cities hit with historic record snow falls

• Weeks with record cold temps in many places

• Droughts and wild fires challenged the West

Early in the quarter, as shown in the panel, we got results on jobs, consumer confidence, auto sales and some on housing that were below expectations. Weather may have been a distortion, however, as the most recent data rebounded.

Weather, weather everywhere…

Housing data mixed but okay for now

Weaker numbers than expected — weather to blame?

January Readings February

Expected Actual Rebound

Industrial production (m/m)1 0.2% -0.3% 0.6%

Nonfarm payrolls2 ($) 180K 129K 175K

Existing home sales (m/m)3 -4.1% -5.1% -0.4%

Auto sales ($)4 15.7M 15.2M 16.3M

Retail sales ex auto & gas (m/m)5 0.1% -0.5% 0.35%

Sources: Bloomberg L.P., BMO Global Asset Management

Sources: Bloomberg L.P., BMO Global Asset Management6 National Association of Home Builders

3

Jobs — broader cross-section of economy

Jobs — structural unemployment in small business trends

Employment remains the sticky wicket. Even with the discount for weather, we have not yet seen strong job creation. But there are positives, including a broader spectrum of jobs being created in services, manufacturing, construction, etc. — a good sign. There are some modest upticks in hourly earnings, as well, and small business on balance shows better sentiment.

• Small businesses are really critical to employment — three of last four surveys showed an increased likelihood of hiring activity.

• Structural challenges remain, however.

There is mounting evidence that structural causes may explain some of the slow jobs recovery. In other words, as our economy has shifted, the education and training necessary for many of the new jobs may not be commensurate with the skillsets required.

• 40% of small business owners who attempted to hire in the past three months reported they found few or no qualified applicants. As the chart shows, in the two prior economic expansions, this pattern also appeared, but with significantly lower unemployment levels.

• Private and public sector job training initiatives (many of which are underway) will take time to gain traction.

Labor leaders and laggards (Y/Y %)

Feb 2014 Jan 2014 Dec 2013

Total nonfarm payrolls 1.59 1.67 1.73

Leisure and hospitality 2.87 3.06 3.25

Construction 2.63 3.19 2.73

Retail trade 1.89 1.89 2.31

Health care 1.56 1.68 1.75

Manufacturing 0.51 0.64 0.74

Government -0.15 -0.13 -0.16

Information -1.56 -0.26 0.00

Sources: Bureau of Labor Statistics, BMO Global Asset Management

Firms reporting none or few qualified applicants/firms hiring in last three monthsUnemployment rate (%)

0

2

4

6

8

10

12

95

90

85

80

75

70

65

60

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2014

Unemployment rate (%) Firms (%) (inverted scale)

Structural unemployment?

Sources: National Federation for Independent Business (NFIB) Research Foundation BMO Global Asset Managment

4

NFIB small business survey of compensation plans

Can trade help the U.S. story?

Improvements in export/import ratio with China

After displaying hopeful trends in December and January, small business optimism slipped in February, with the weather likely playing a major role. Interestingly, while sales expectations and hiring plans took a step back, current and future compensation indicators stayed steady or pushed higher. • Additionally, a net 23% of business

owners noted they planned to raise prices in the next three months, the most since February of last year.

Over the past few years the competitive position of the U.S. economy has improved. After a nearly 50% rise from 1995 to 2001 rendered the U.S. dollar expensive, the retracement over the last 10 to 12 years has contributed to our improved trade balance.

• Rising exports continue to provide a positive tailwind to U.S. growth and significantly added to GDP in the fourth quarter.

• Interestingly, if you exclude the effects of China and petroleum, the U.S. is actually running a trade surplus.

Our trade deficit with China has improved. A few key factors include:

• Since 2005 the Chinese have let the yuan appreciate relative to the U.S. dollar by nearly 35%.

• This brings the U.S. ratio of exports to imports from 16% to 30%.

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

5

10

15

20

25Net percent increase in the next three months

NFIB small business economic trends (compensation plans)

Sources: National Federation of Independent Business (NFIB) BMO Global Asset Management Chart #3002.1

Dollars ($B)

-400

-300

-200

-100

0

100

19961994 1995 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Exports provided 1% of 2.4% overall Q4 2013 GDP

Percent

14

16

1820

22

24

26

28

30

19961994 1995 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

In the last several years, China allowed the Yuan/USD pegto begin drifting higher from 2005 through 2008 and again in 2010

U.S. rolling 12 months trade deficit ex China and ex Petroleum

U.S. trade deficit with China (rolling 12-month ratio)

Sources: U.S. Census Bureau, BMO Global Asset ManagementNote - China trade is goods only. Overall trade balance includes services. Chart # 2262

Sources: U.S. Census Bureau, BMO Global Asset Management Chart #2016.3

5

Happy anniversary Mr. and Mrs. Stock Market

Strong returns but significant differences across S&P 500® sectors

On March 9, 2014 the bull market celebrated its five-year anniversary. It seems like yesterday we were watching with abject fear as markets dramatically spiraled downward and the Dow Jones Industrial Average itself seemed on the verge of extinction. Now, five years later, the markets have compounded upward at a rate of 23% per year on the Dow and 25% for the S&P 500.®

Of course, a wild party seems inappropriate as our economic and jobs growth remains sub-par for a “recovery.” But it was a big, big fall; and there is at least modest progress across several areas, including consumer confidence, corporate profits, manufacturing, housing and auto sales.

Earnings, price-to-book value and dividend yields have all retraced above their pre-recession peaks. Prices relative to profits (P/E ratio) are currently 17x versus a 25-year average of 19x.

• During this five-year period, six sectors compounded in excess of 25% each. The leaders included Consumer Discretionary, Financials, Industrials, Information Technology, Materials and Health Care.

• The more “defensive” sectors such as Utilities and Telecommunications were up nicely – 17% each — but well below sectors more associated with economic recovery.

Oct 2007 2008 2009 2010 2011 2012 2013 April 1, 2014600

800

1000

1200

1400

1600

18002000

Total annualized returns (%) 3/9/09 – 3/9/14S&P 500®: 25.31Dow Jones: 23.54NASDAQ: 29.42

peak on 10/9/07:1565

Index

6

7

8

9

10

11

12

13

Dec 2007

Jun2008

Dec 2008

Jun2009

Dec 2009

Jun2010

Dec 2010

Jun2011

Dec 2011

Jun2012

Dec 2012

Dec 2013

Jun2013

12.06%of GDP

Corporate profits$1.0T (2008) vs.$2.1T (2013)

Percent

The bull turns five — S&P 500® Index

Corporate profits as percent of Gross Domestic Product (GDP)



S&P 500® valuation

Peak (10/9/2007) Trough (3/9/2009) Now (3/9/2014)

Earnings per share 89.38 64.66 108.54

Price/book value 2.98 1.51 2.62

Dividend yield 1.78 3.50 2.06

S&P 500® sectors Price change (%) Total return (%)

Consumer discretionary 324 36

Financials 259 31

Industrials 243 31

Information technology 199 26

Materials 177 25

Health care 171 25

Consumer staples 118 21

Energy 106 18

Utilities 77 17

Telecommunications services 68 17


3/9/2009-3/9/2014, total returns annualizedSources: Bloomberg L.P., BMO Global Asset Management

6

Volatility index responds to geopolitics

Sector weights and trailing P/Es Returns

S&P 500® sector Weight (%) Q1-14 (%) 2013 (%) Trailing P/Es

Information technology 18.7 2.28 28.43 17.9x

Financials 16.4 2.61 35.59 13.8x

Health care 13.4 5.81 41.46 20.0x

Consumer discretionary 12.2 -2.80 43.08 20.4x

Industrials 10.7 0.14 40.64 18.1x

Energy 10.1 0.78 25.05 14.7x

Consumer staples 9.6 0.50 26.14 18.7x

Materials 3.5 2.86 25.60 17.7x

Utilities 3.0 10.09 13.21 17.1x

Telecommunications 2.4 0.47 11.47 15.6x

S&P 500® Index 100.0 1.81 32.38 17.2x

U.S. equities



Returns (%) Trailing as of 3/31/14

Index Q1-14 2013 1-year 5-year

S&P 500® 1.81 32.38 21.85 21.15

Dow Jones (DJIA) -0.15 29.65 15.66 19.85

Russell 1000® 2.05 33.11 22.41 21.73

Russell 2000® 1.12 38.82 24.90 24.31

NASDAQ 0.84 40.17 30.24 23.87

After a strong 30+% gain in 2013 and a solid 16% move up in 2012, stocks in the first quarter inched slightly higher. Several factors were in play during the quarter:

• Russia/Ukraine conflict

• Concerns on China and EM

• Some weaker U.S. economic data

However, companies reported strong corporate earnings for the fourth quarter, with 70% beating sales and earnings expectations.

• VIX: The Chicago Board Options Exchange Volatility Index (VIX) jumped quickly in mid-January, illustrating how sensitive this market is to adverse developments.In the first quarter, those tended to be geopolitical or emerging market concerns.

• In January, the uprising in Turkey, problems in Argentina, etc. spiked the VIX while markets fell. Most recently, the same occurred after the Russia/Ukraine breakout.

S&P

<––Turkey, et al. Russia/Ukraine ––>

VIX

S&P 500® IndexVIX Index

1700

1740

1780

1820

1860

1900

10

12

14

16

18

20

22

January 2014 February 2014 March 2014

S&P 500® and VIX Indices


7

Political dysfunction and policy uncertainty may be softening, e.g. debt ceiling and budget deals were struck, the Affordable Care Act (ACA) is more “known” and the U.S. current account deficit is shrinking.

• Over the past year, business owners have identified policy uncertainty as one of the reasons they were reluctant to expand business/CAPEX.

• As you can see in the chart, the Economic Policy Uncertainty Index peaked in 2010 and CAPEX dropped at the same time; but we are now getting some retracement to decreasing uncertainty and increasing CAPEX (up 12% year- over-year in the fourth quarter).

After years of companies becoming more efficient at turning modest sales growth into large earnings increases, we may be at a point in the cycle where stronger revenue growth is necessary for future appreciation. However, investors should be comforted that companies are healthy and generating sizeable cash flows.

• Cash flow tracks actual dollars flowing through the corporation and adds back any non-cash charges. It is the lifeblood of a company as it provides flexibility to manage through tough times.

• Investors also benefit from cash flow because it is available to be returned to them. Currently, companies continue to increase dividends and buy back shares, for example.

Free cash flow (FCF)

Capital expenditures (CAPEX) finally start to pick up

Percent

0

2

4

6

8

10

12

19961990 1992 1994 1998 2000 2002 2004 2006 2008 2010 2012 2014

19961987 1990 19941992 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Nonfinanicial businessCAPEX fixed investment ( )

(smoothed 12 months Y/Y% change)Economic Policy Uncertainty Index ( )(smoothed and led 12 months Y/Y% change, inverted)

Less policy-related economic uncertainty — increasing CAPEX

Greater policy-related economic uncertainty — decreasing CAPEX-30

-20

-10

0

10

20

30

40-80�

-60�

-40�

-20�

0�

20

�

40

�

60

�

80

�

S&P 500® free cash flow yield

Economic policy uncertainty and capital expenditures

Sources: Bloomberg, BMO Global Asset Management Chart #2108

Sources: Economic Policy Uncertainty, Federal Reserve, BMO Global Asset Management Chart #3008.1

8

Sources: bbc.com, Bloomberg L.P., BMO Global Asset Management

2.5

2.6

2.7

2.8

2.9

3.0

3.1

January 2014 March 2014February 2014 April 2014

2

314

Percent10-year Treasury yield

U.S. fixed income

It is interesting to note how yields and yield spreads have compressed. As the chart shows, the yields and spreads between high yield bonds and investment grade bonds are well below their average levels since 2000. Sources: Barclays, BMO Global Asset Management

High Yield versus Investment Grade

Spread (HY/IG) Yield (HY/IG)

3/31/14 251.33 2.12

Average 2000 - 2014 424.34 4.34

Sources: Barclays 1-Year Treasury Bellwether Index, Barclays 10-Year Treasury Bellwether Index, Barclays U.S. Aggregate Bond Index, Barclays U.S. Corporate High Yield Bond Index,

S&P/LSTA Leveraged Loan Index, Barclays Emerging Markets USD Aggregate Index, BMO Global Asset Management

Is yield compression ending?

Geopolitics around the globe chased investors to the U.S. Treasury for safety, and that demand helped keep rates in check, as well as some of the weaker, weather-related economic data.

Geopolitics and U.S. Treasury rates

All the worries of the impact of rising rates due to a slowdown of quantitative easing (QE) and an improving economy did some damage in 2013 to bond investors. However, in the first quarter of 2014, Treasury yields moved within a fairly narrow range (see chart). As a result, fixed income returns for the quarter were in positive territory with the 10-year Treasury up 3.4% versus -7.8% last year.



1-year treasury 0.05 0.29 0.28 0.55

10-year treasury 3.38 -7.81 -4.39 3.10

Investment grade 1.84 -2.02 -0.10 4.80

High yield 2.98 7.44 7.54 18.25

Adjustable bank loans 1.20 5.29 4.35 12.52

EM debt 2.82 -4.12 0.04 12.45

1 1/31/2014 Argentina, South Africa, Brazil all struggle.

2 2/22/2014 Ukraine outbreak. Ukrainian president ousted.

3 2/27/2014 Russia seizes and annexes Crimea.

4 3/3/2014 China currency weakens.

9

Investors, after years of moving money from stocks to bonds, began to reverse some of that.

• Investors have slowed the bond rush

• Largest equity flows went to international stocks

• U.S. equities the next biggest

Following ex-Fed Chairman Bernanke’s initial QE tapering comments back in May 2013, over the next few months the Fed worked diligently to assert that “tapering” was not “tightening.” The market grasped the concept after the Fed decided to not begin tapering in September 2013.

• The Fed remains on message and even following the taper commencement in December 2013, the markets continue to believe that Fed Funds tightening will not start until 2015.

Fund flows — retail investors look to equities

Anchoring the short-term curve

Lipper category 2013 2014 ytd1

US Equity 117 33

International Equity 166 34

Total Equity 283 67

Taxable Bond 16 15

Tax-Free Bond -58 2

Total Bond -42 17

Total 241 84

1 As of February 28, 2014Sources: Strategic Insight, BMO Global Asset Management

0.0

0.5

1.0

1.5

2.0

09/10/2013 Fed Fund futures curveCurrent Fed Fund futures curve05/02/2013 Fed Fund futures curve

Mar2015

Apr2015

May2015

Jun2015

Jul2015

Aug2015

Sep2015

Oct2015

Nov2015

Dec2015

Jan2016

PercentThe fed has successfully “anchored” the front end of the curve


Flows into Mutual Funds ($B)

10

Labor force — still work to be done

Developed world/EAFE

Germany, the UK and France generally are center stage in the Eurozone. However, we wanted to revisit how the periphery countries are faring by looking at some of the key metrics and current conditions across Italy, Spain, and Greece.

In general, many of the metrics are dramatically better than during the crisis. Current account deficits are way down; sovereign interest rates (and thus borrowing costs) are down dramatically; stock markets are up, etc. So the efforts at austerity produced some results.

However, while encouraging, there remain challenges to generating growth including higher labor force participation rates required, achieving social reforms, moving up lending activity, etc. So there is a lot to be done, and the road is long.

• Low labor-force participation rates contribute to lower GDP results and expectations. For example, average GDP growth over the past decade for Japan is 0.9% and for 0.7% for Italy.

Where are the peripheries now? Encouraging steps forward

The Eurozone is doing a bit better. GDP is in positive territory; Germany (the biggest economy) is steady; the UK is moving to higher ground and the European stock exchanges responded well in 2013 and 2012. In the near term, however, the geopolitics of Russia/Ukraine have constrained equity results.



STOXX 600 2.60 21.56 17.65 17.99

Nikkei -8.33 59.28 21.35 14.91

MSCI EAFE 0.66 22.78 17.56 16.02

Stock market returns (%)1

10-year yields (%) 3/30/10-now

Current account deficits as % GDP

Q1-14 2013 Peak rate 3/31/14 2012 2013e 2014e 2015e

Italy 14.38 20.29 7.26 3.29 -3.0 -3.1 -2.8 -2.5

Greece 14.93 29.68 37.10 6.57 -9.0 -13.5 -2.3 -1.9

Spain 5.26 27.77 7.62 3.23 -10.6 -6.8 -5.9 -4.8

Retail sales (%)2 Manufacturing (%)3

3/31/13 6/30/13 9/30/13 12/31/13 3/31/13 6/30/13 9/30/13 12/31/13

Italy -4.8 -3.0 -2.8 -2.6 -9.7 -5.1 0.2 -2.4

Greece -5.9 -7.7 -6.3 -6.7 -0.7 0.4 -1.8 0.5

Spain -10.8 -6.9 2.1 -0.1 -10.4 -4.7 3.6 3.9

ItalyU.S. Japan Germany France

1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 201440 �

45 �

50 �

55 �

60 �

65 �

70 �

�

�

Percent

Unemployment rates remain in double digits in periphery countries

Labor force participation rates

Note: Participation rates through 12/31/12, Sources: Bloomberg, BMO Global Asset Management Chart #2267.1

1 per FTSE MIB Index, ASE Index and IBEX 35 Index 2 Y/Y retail sales, 3 Y/Y industrial production



1 1

• During the month of January, the Japanese nominal trade deficit spiked to 2.79 trillion yen. That was the 19th straight month of deficits.

• The culprit in the nominal trade deficit rise has been a spike in the cost of imported energy. This has occurred because Japan shut down their nuclear power capabilities in after the 2011 Fukushima disaster — requiring more energy imports.

• Faced with this “roadblock” to his reflationary plan, Abe has stated that he will be restarting some of the plants later this year.

One of the objectives of Abenomics is to reinvigorate the export sector, in part by depreciating the Japanese yen. While that policy helped ignite a stock market rally and yen decline, the results in the export sector have been disappointing.

Another objective of Abenomics is to create wage growth. There have been signs of “hope” during 2013. However, early numbers of 2014 were still weak.

• The Abe government has privately pressured Japanese corporations to raise wages, and it appears he is having some success. Research firm ISI has tabulated that 38 Japanese companies have announced wage increases this year.

• Wage inflation is crucial to ending deflation because it is “stickier” than recent energy price inflation.

Abenomics and strong push to increase wages

Japan’s rapid stock market rise of last year suffered a pullback in the first quarter, falling 8.3%. Some of the encouraging economic data of higher inflation, improved consumer sentiment and stronger exports on the back of a weaker yen are being challenged. Recent growth rates have slowed including GDP and inflation. The initiatives of Shinzo Abe (“Abenomics”) will be closely watched this year to see if the economic climate can be improved and sustained.

Japan trade balance with foreign countries importsJapan trade balance with foreign countries exports

-10

-5

0

5

10

15

20

25

30

October 2012 January 2013 October 2013 January 2014April 2013 July 2013

Y/Y (%)

-8

-6

-4

-2

0

2

46

8

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2014

Y/Y (%)

Japan nominal imports/exports

Japanese average monthly cash earnings NSA

Sources: Ministry of Finance Japan, BMO Global Asset Management Chart #2215

Sources: Ministry of Health, Labor and Welfare, BMO Global Asset Management Chart #2215.9

Abenomics and Japan trade balance

12

Sources: World Bank, BMO Global Asset Management

China

China is working to diversify their economy from being trade- and foreign-investment centered to one that increasingly relies on consumption and investment.

• Auto sales in China exceed those in the U.S. and have nearly tripled since 2005.

However, in spite of the official views and efforts, the markets seem more concerned that growth will fall short, and that credit risk is rising.

• Bank loans represent over 50% of China’s financial structure.

• Non-performing loans (NPLs) are on the rise as housing has boomed, yet NPLs still represent a small percentage of total assets.

• Government intervention always a potential.

Diversifying the economy

Retail sales — consumer a growing part of China’s profile

Credit risk

China non-performing loans at commercial banks

Markets in China and the emerging markets (EM) in general suffered another difficult quarter, even though the Chinese government reiterated their projected growth for 2014 to hit the 7.5% mark.



Shanghai SE Composite -3.90 -3.88 -6.27 -0.97

Hang Seng -4.55 6.56 2.94 13.96

China growth model projections

U.S. auto sales versus Chinese auto sales

1995 - 2010 2011 - 2015 2016 - 2020 2021 - 2025 2026 - 203020

40

60

80IndustryInvestment ServicesConsumption

Percent

2005 2006 2007 2008 2010 2011 2013 20142009 20120

500,000

1,000,000

1,500,000

2,000,000U.S. auto sales NSA Chinese auto sales NSA

Units

400

450

500

550

600

Dec2013

Sep2013

Jun2013

Mar2013

Dec2012

Sep2012

Jun2012

Mar2012

Dec2011

Sep2011

Jun2011

Mar2011

Dec2010

Total NPLs USD = 100BTotal NPLs Yuan= 590BTotal NPLs as % total outstanding loans = 1%

Yuan (B)


Sources: Strategas Research Partners, China Banking Regulatory Commission, People’s Bank of China, Bloomberg L.P., BMO Global Asset Management


Disturbance in Ukraine

13

Emerging markets

During the first quarter, the Ukraine disturbance hit the Russian stock market hard and the Russian ruble, as well. As one of the key BRIC countries, this performance impacted overall EM, BRIC results.

The EM markets and BRICs in particular had a difficult quarter. Between China concerns, Brazil and India struggling with their economies, and Russia’s grab at Crimea, it was a difficult environment for stocks. Some also worry another Asian currency crisis could be looming. However, emerging markets have built sizeable reserves and also have “unpegged” themselves from the U.S. dollar.



MSCI EM -0.43 -2.60 -1.43 14.48

MSCI BRIC -2.89 -3.53 -3.19 7.93



U.S. Dollar versus Russian Ruble

Russian MICEX Index: -9.0% ytd

37

36

35

34

33

32

4/1/143/26/143/18/143/6/142/28/142/20/142/12/142/4/141/27/141/17/141/9/141/1/14

1 USD per 32 RUB (inverted scale)

Foreign exchange reserves

Currency concerns have plagued Asia since the “Asian Contagion” of the late 1990s. However, many of these economies have now built substantial foreign exchange reserves and, in many instances, decoupled their currencies from the U.S. dollar, thereby lessening the probability of another currency crisis.

• Over the past 10 years, developing economies have built up their foreign exchange reserves.

• China remains the largest holder of foreign exchange reserves among developing economies, while Japan tops the list of developed economies.

Sources: International Monetary Fund, BMO Private Bank File #2046

Who owns the world’s foreign exchange reserves

1999 2000 2001 2002 2004 2005 2007 2008 2009 2010 2011 2012 2013 20142003 2006

% of total foreign exchange reserves held by industrial economies% of total foreign exchange reserves held by developing economies

0

10

20

30

40

50

60

70

80Percent

14

Themes, headwinds and tailwinds

Region Economic/market themes Headwinds Tailwinds

U.S.

Monetary: direction clarified; expect $10B per Fed mtg, unless data contravenes Potential consequences of "taper" progression Still relative low interest rates — but "taper"

progression may lessen this tailwind

Fiscal: budget and debt ceiling step aside for now; entitlements unaddressed New Fed Chair — continuity of policy for now Geopolitics help keep rates down

Economy: slow growth, unemployment improves — weather-related impact a question Entitlement and tax reform struggles Improving trends for mfg/services

Markets (equity): corp. earnings and sales (growth key issues), equity valuations ok, balance sheet strength. Q4 results beat estimates

Economic slack: real wages stalled and weak velocity of money Leading economic indicators rise

Markets (fixed income): search for yield continues, QE slowdown impact on rates. Yields down in early 2014

Weaker recent job numbers — weather to blame? Recent increases in NFIB

Consumer: still solid confidence, direction of housing and autos still pivotal Rotation from bonds to stocks under way Natural gas positive impact, but prices rising

— weather effect

Modest top line growth for U.S. companies Wealth effect still at work

Mortgage rate impact on housing story Recent nonfarm payroll growth needs to resume after two weak jobs reports

Recent demand for treasuries as safe haven for crises in Turkey, Ukraine, Argentina, etc.

Developed (ex U.S.)

Europe: economy moves out of recession, low rates continue as ECB cut rates; initiatives for growth essential. ECB may yet try more moves

Europe: needs growth as austerity measures hit, labor costs out of line, unemployment quite high in many countries; no serious growth

Europe: improved results in UK, Italy, Spain across mfg/services. German outlook still positive, lowered borrowing costs still intact

Japan: fiscal, monetary stimulus underway, structural and tax reforms coming. Future directions are still a concern

Japan: can it stay out of deflation, will initiatives take hold; aging population, strength of structural reforms is in question. Recent Japan data weaker

Russia/Ukraine crisis

Japan: some recent signs of inflation uptick, consumer confidence coming back, LEIs on the rise

EM

General economic growth still north of 4-5% in aggregate for 2013

Taper decision impacts these markets, but may be getting "baked in" Urbanization underway

India and Brazil struggle with slowing growth and rising inflation

Challenges in some countries to fight inflation without damage to growth Consumer grows in importance

Potential China slowdown Labor cost advantage

Rich resources

China

GDP growth stabilizing in 7.5% range, but direction an issue Lending/leverage risks GDP and trade numbers bear watching

Consumer increases as % of economy Housing bubble? GDP slowing but still above 7%

Move away from fossil fuels Trade/consumption & private investment shifts Retail sales & mfg stay positive

Aging population Policy — mistake risk Solid auto sales growth

Export rebound Lending up, but…

The panel below lists several themes we feel are key across major regions and countries of the world. A shorthand list of headwinds and tailwinds are shown for each.

15

Given the current themes, headwinds and tailwinds on the previous page, the scorecard below represents our current major asset allocation views, which are reviewed on an ongoing basis.

Simplified scorecard

Asset class Less attractive Neutral More attractive

EQUITIES n

All cap U.S. equity n

Large cap core equity n

Midcap core equity n

Small cap core equity n

Int'l equity and emerging market n

FIXED INCOME n

Core U.S. bonds n

U.S. below investment grade bonds n

Emerging market bonds n

International investment grade bonds n

1 - 10-year municipal bonds n

High yield municipal bonds n

PRIVATE EQUITY n

REAL ASSETS n

HEDGE FUNDS n

Fixed income

16

Global returns

Equities

• U.S. stocks inched slightly higher in the first quarter.

• Geopolitics across Ukraine, Russia, Turkey and Argentina held markets in check.

• Wicked weather contributed to weaker economic data in U.S. such as hiring, home building, etc. and also held back stocks. Some weather rebound in most recent data.

• Developed world, particularly Europe, hurt by Ukraine crisis.

• Japan stocks pulled back as new initiatives still await.

• Concerns on China growth and credit kept EM market in check.

• Weaker U.S. economic data (weather a causal factor) and geopolitics helped keep 10-year Treasury yields in check.

• 10-year Treasury ended up posting a positive return for the quarter of 3.4% versus a -7.8% loss for 2013.

• High yield and investment grade corporates led the pack.

• Very compressed yield spreads.

• Emerging market debt enjoyed a good quarter, as well.

Fixed income (% returns) Trailing as of 3/31/14

Q1-14 2013 1-year 3-year 5-year 10-year

Barclays U.S. Aggregate Bond Index 1.84 -2.02 -0.10 3.75 4.80 4.46

Barclays U.S. Treasury Index 1.34 -2.75 -1.26 3.40 2.69 4.05

Barclays U.S. Corporate Index 2.94 -1.53 1.47 6.08 9.69 5.29

Barclays U.S. Corporate High Yield Index 2.98 7.44 7.54 9.00 18.25 8.68

Barclays Global Aggregate Bond Index 2.40 -2.59 1.88 2.78 5.10 4.50

Barclays EM USD Aggregate Index 2.82 -4.12 0.04 6.98 12.45 8.48

Sources: Barclays, Bloomberg L.P., BMO Global Asset Management

Equities (% returns) Trailing as of 3/31/14

Q1-14 2013 1-year 3-year 5-year 10-year

S&P 500® Index 1.81 32.38 21.85 14.65 21.15 7.42

Dow Jones Industrial Average Index -0.15 29.65 15.66 13.05 19.85 7.47

NASDAQ Composite Index 0.84 40.17 30.24 16.27 23.87 8.97

MSCI EAFE Index (Developed Markets) 0.66 22.78 17.56 7.21 16.02 6.53

MSCI Emerging Markets Index -0.43 -2.60 -1.43 -2.86 14.48 10.11

MSCI BRIC Index -2.89 -3.53 -3.19 -6.86 7.93 8.41


17

1 HFRI indicies reporting lagged. Returns as of 2/28/14 Sources: Bloomberg L.P., Hedge Fund Research, BMO Global Asset Management

• REITs had a great quarter.

• Some pickup in lending to commercial/industrial sector.

• Hedge funds fared a bit better.

• Yen still much weaker than a year ago, but holding in 100-105 range.

• Euro remains strong – even with weak growth outlook.

• Dollar continues to hold its own .

Other assets (% returns) Trailing as of 3/31/14

Q1 2013 1-year 3-year 5-year 10-year

FTSE NAREIT All Eq REITs Index 8.52 2.85 3.23 10.43 28.31 3.58

Dow Jones-UBS Commodity Index 6.99 -9.58 -2.10 -7.37 4.24 0.43

HFRI FOF Diversified Index1 1.01 9.04 6.65 2.83 5.10 3.29

HFRI Equity Hedge (Total) Index1 1.63 14.29 10.69 3.90 9.70 5.10

Other assets

Currency panel

3/31/13 6/30/13 9/30/13 12/31/13 3/31/14

Yen/USD 94.22 99.14 98.27 105.31 103.23

Euro/USD 1.28 1.30 1.35 1.37 1.38

USDX 82.98 83.14 80.22 80.04 80.10

The USDX (US Dollar Index) indicates the general international value of the USD. The Index does this by averaging the USD and major world currencies.


18

Investments cannot be made in an index.ASE Index The Athens Stock Exchange General Index is a capitalization-weighted index of Greek stocks listed on the Athens Stock Exchange.

Barclays 1-10 yr Municipals Index is a market value-weighted index which covers the short and intermediate components of the Barclays Municipal Bond Index — an unmanaged, market value-weighted index which covers the U.S. investment-grade tax-exempt bond market.

Barclays Emerging Markets Corporate Index is a component of the Barclays U.S. Emerging Markets Index which is made up of debt issued by corporations.

Barclays EM USD Aggregate Index is a flagship hard currency Emerging Markets debt benchmark that includes USD denominated debt from sovereign, quasi-sovereign and corporate EM issuers.

Barclays Global Aggregate Bond Index is an index of global government, government-related agencies, corporate and securitized fixed-income investments.

Barclays U.S. Aggregate Bond Index covers the U.S. investment-grade fixed rate bond market, including government and credit securities, agency mortgage pass-through securities, asset-backed securities and commercial mortgage-based securities. To qualify for inclusion, a bond or security must have at least one year to final maturity, rated investment grade Baa3 or better, dollar denominated, non-convertible, fixed rate and be publicly issued.

Barclays U.S. Corporate Index is designed to measure the performance of the U.S. corporate bond market.

Barclays U.S. Corporate High-Yield Bond Index is an unmanaged index that covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market.

Barclays U.S. Treasury Bellwether Indices are a series of benchmarks tracking the performance and attributes of six on-the-run U.S. Treasuries that reflect the most recently issued 3m, 6m, 2y, 3y, 5y, 10y and 30y securities. The bellwether indices follow Barclays’ index monthly rebalancing conventions. The U.S. Treasury Bellwether Indices contain index history starting January 1, 1981.

Barclays U.S. Treasury Index is an unmanaged index that includes a broad range of U.S. Treasury obligations and is considered representative of U.S. Treasury bond performance overall.

Chicago Board Options Exchange Volatility Index (VIX) reflects a market estimate of future volatility, based on the weighted average of the implied volatilities for a wide range of strikes.

DAX Index The German Stock Index is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange.

Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and NASDAQ.

Dow Jones–UBS Commodity Index is composed of commodities traded on U.S. exchanges.

FTSE NAREIT All Eq REITs Index contains all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property that also meet minimum size and liquidity criteria.

FTSE MIB Index consists of the 40 most liquid and capitalized stocks listed on the Borsa Italiana.

Hang Seng Index is a free-float capitalization-weighted index of selection of companies from Stock Exchange of Hong Kong. The components of the index are divided into four subindexes: Commerce and Industry, Finance, Utilities, and Properties.

HFRI Equity Hedge (Total) Index is a fund-weighted index of select hedge funds focusing on Equity Hedge strategies. Equity Hedge investing consists of a core holding of long equities hedged at all times with short sales of stocks and/or stock index options.

HFRI FOF Diversified Index invests in a variety of strategies among multiple hedge funds managers. A fund in the HFRI FOF Diversified Index tends to show minimal loss in down markets while achieving superior returns in up markets.

IBEX 35 Index is the official index of the Spanish Continuous Market. The index is comprised of the 35 most liquid stocks traded on the Continuous market.

MICEX Index is cap-weighted composite index calculated based on prices of the 50 most liquid Russian stocks of the largest and dynamically developing Russian issuers presented on the Moscow Exchange.

MSCI BRIC Index is a free float weighted equity index designed to measure performance of the following four emerging market country indices: Brazil, Russia, India and China.

MSCI EAFE Index (Developed Markets) is a standard unmanaged foreign securities index representing major non-U.S. stock markets, as monitored by Morgan Stanley Capital International.

MSCI Emerging Markets Index is a market capitalization weighted index comprised of over 800 companies representative of the market structure of the emerging countries in Europe, Latin America, Africa, Middle East and Asia. Prior to January 1, 2002, the returns of the MSCI Emerging Markets Index were presented before application of withholding taxes.

NASDAQ Composite Index is a broad-based capitalization-weighted index of all NASDAQ National Market & Small Cap stocks.

Nikkei-225 Stock Average is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange.

Russell 1000® Index measures the performance of the large-cap segment of the U.S. equity universe.

Russell 2000® Index is a subset of the Russell 3000® Index, including approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.

Shanghai Stock Exchange Composite Index is a capitalization-weighted index. The index tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange.

S&P 500® Index is an unmanaged index of large-cap common stocks.

S&P/LSTA Leveraged Loan Index is a daily index that uses LSTA/LPC Mark-to-Market Pricing to calculate market value change. On a real-time basis, the LLI tracks the current outstanding balance and spread over LIBOR for fully funded term loans.

STOXX Europe 600 Index represents 600 large, mid and small capitalization companies across 18 countries of the European Region.

This is not intended to serve as a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. Information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. This publication is prepared for general information only. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investment involves risk. Market conditions and trends will fluctuate. The value of an investment as well as income associated with investments may rise or fall. Accordingly, investors may receive back less than originally invested.

Past performance is not necessarily a guide to future performance.BMO Global Asset Management is the brand name for various affiliated entities of BMO Financial Group that provide investment management, retirement and trust and custody services. Certain of the products and services offered under the brand name BMO Global Asset Management are designed specifically for various categories of investors in a number of different countries and regions and may not be available to all investors. Products and services are only offered to such investors in those countries and regions in accordance with applicable laws and regulations. BMO Financial Group is a service mark of Bank of Montreal (BMO).

Investment products are: NOT FDIC INSURED — NO BANK GUARANTEE — MAY LOSE VALUE.

© 2014 BMO Financial Corp.

13-325-040

Investments cannot be made in an index.This is not intended to serve as a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. Information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. This publication is prepared for general information only. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investment involves risk. Market conditions and trends will fluctuate. The value of an investment as well as income associated with investments may rise or fall. Accordingly, investors may receive back less than originally invested.Past performance is not necessarily a guide to future performance.BMO Global Asset Management is the brand name for various affiliated entities of BMO Financial Group that provide investment management, retirement and trust and custody services. Certain of the products and services offered under the brand name BMO Global Asset Management are designed specifically for various categories of investors in a number of different countries and regions and may not be available to all investors. Products and services are only offered to such investors in those countries and regions in accordance with applicable laws and regulations. BMO Financial Group is a service mark of Bank of Montreal (BMO).BMO Harris Financial Advisors, Inc., BMO Private Bank and BMO Global Asset Management are affiliated companies. Securities, investment advisory services and insurance products are offered by BMO Harris Financial Advisors, Inc. Member FINRA/SIPC. SEC-registered investment adviser. BMO Harris Financial Advisors, Inc. and BMO Harris Bank N.A. are affiliated companies. BMO Private Bank is a brand name used in the United States by BMO Harris Bank N.A. Member FDIC. Not all products and services are available in every state and/or location.Securities, investment advisory and insurance products are: NOT FDIC INSURED | NOT BANK GUARANTEED | MAY LOSE VALUE. © 2014 BMO Financial Corp.13-325-040 BHFA

market q1 2014 quarterly review - bmo harris bank · the following review of the first quarter...

Documents