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Asset Allocation: ‘Scenic Route’ For Fed Should Lend Support To Risk Assets

As we move into 2016, investors are anticipating a period of sustained interest rate increases by the Federal Reserve – not an aggressive climb as sometimes seen in the past, but a mild, steady stroll to modest heights. Meanwhile, Europe and Japan remain on level policy ground, as they look to quantitative easing to maintain recovery and avert further contraction, respectively. Potential turbulence in the form of slowing Chinese growth could make the journey a bit uncomfortable, given that country’s central role in global economic health. Putting all this together, the Neuberger Berman Asset Allocation Committee believes that still-friendly monetary conditions and gradual economic improvement should lend support to risk assets and underscore our preference for stocks over bonds in the coming year. Global Equities: Leaning into Europe We are positive on global equities, particularly in Europe, where stocks stand to benefit from continued quantitative easing and a weaker euro. While we had an overweight view on U.S. stocks just a few months ago in light of reasonable valuations and potential for earnings improvement in 2016, that positioning has moved to neutral given the sharp price recovery in October. However, we see opportunity in master limited partnerships, which, despite near-term concerns around energy prices and the sustainability of distributions, still appear to offer attractive valuations and yields. We are relatively cautious on Japan’s market. Although stocks are benefiting from the weak yen and reallocation of pension fund assets, the country faces slow or negative growth and is vulnerable to a slower Chinese economy. Elsewhere, we have a neutral view of emerging markets, where China volatility, commodity weakness and dollar strength are creating economic headwinds, while corporate profitability remains under pressure. In our view, selectivity from a country and company perspective remains paramount. Fixed Income: Appeal of Spreads We are underweight global fixed income for the coming year given our low return outlook for the large, developed-country sovereign bond markets in light of a trend toward higher rates in the U.S. and easy policy in Europe and Japan. In the U.S., we believe the Fed’s rate normalization will be a dovish process relative to past tightening cycles. A meaningful spike in long-term rates appears unlikely to us, but investors should be prepared for periods of heightened volatility. We maintain a preference for credit based on our outlook for modest economic growth and current attractive spread levels. In particular, we see appeal in high yield, where spreads remain at wide levels due to commodity-related weakness. In our view, credit quality among issues in the rest of the high yield universe remains quite good. Credit fundamentals in emerging markets debt remain relatively strong, in large part due to higher reserve levels and much-improved policymaking over the last two decades. Recent troubles, however, have exacerbated weak growth stemming from soft domestic demand in the major emerging markets. We are neutral on a one-year horizon, but are more constructive further out, as we believe the developed market recovery should lend support to emerging markets’ growth and credit fundamentals. Alternatives: Directional Hedge Funds Could Benefit from Volatility Within alternatives, we now have a slightly overweight stance on directional hedge funds, as increased volatility is creating more opportunities for astute traders and active managers to add value. Within this group, distressed managers have suffered in 2015 from exposure to Puerto Rico, Greece and the energy sector, but we believe there are ample opportunities over a 12-month time horizon. We have a modest overweight view on lower-volatility hedge funds and believe that they continue to play an important role in asset allocations, particularly in an environment of higher volatility and likely rising rates in the U.S. Our view on private equity continues to be neutral in light of its long cycle of growth and more elevated valuations. Elsewhere, we are neutral on commodities – an improvement from six months ago – believing that these markets have come under so much pressure that they are not likely to deteriorate much further. China growth concerns may lend support to precious metal prices, while the drought in many parts of the U.S. should help soft and agriculture commodities. We believe oil is likely to be range-bound, but we anticipate better supply/demand dynamics on the margin. For the broader commodity complex, the potential for higher interest rates and the resulting stress on certain commodity producers may lead to production cuts and more balance across markets. Uncertain Journey We believe elevated uncertainty is likely to accompany investors for much of 2016, whether around future monetary policy, geopolitical events, the price of oil or the extent of slowing growth in China. We will continue to monitor developments as we seek to provide guideposts for the current challenging environment. Market Views Based on 1-Year Outlook for Each Asset Class Regional Focus Fixed Income, Equities and Currency * The currency forecasts are not against the U.S. dollar, but stated against the other major currencies. As such, the forecasts should be seen as relative value forecasts and not directional U.S. dollar pair forecasts. Currency forecasts are shorter-term in nature, with a duration of 1-3 months. Regional equity and fixed income views reflect a 1-year outlook. The Committee members are polled on the asset classes listed above, and these discretionary views are representative of an Asset Allocation Committee consensus. As of fourth-quarter 2015. Views expressed herein are generally those of the Neuberger Berman Asset Allocation Committee and do not reflect the views of the firm as a whole. Neuberger Berman advisors and portfolio managers may make recommendations or take positions contrary to the views expressed. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. About the Asset Allocation Committee Neuberger Berman’s Asset Allocation Committee meets every quarter to poll its members on their outlook for the next 12 months on each of the asset classes noted. The committee covers the gamut of investments and markets, bringing together diverse industry knowledge, with an average of 24 years of experience. This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events may differ significantly from those presented. Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Diversification does not guarantee profit or protect against loss in declining markets. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results. All information as of the date indicated. Firm data, including employee and assets under management figures, reflect collective data for the various affiliated investment advisers that are subsidiaries of Neuberger Berman Group LLC (the “firm”). Firm history includes the history of all firm subsidiaries, including predecessor entities. This material is being issued on a limited basis through various global subsidiaries and affiliates of Neuberger Berman Group LLC. 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Car Hops To Camelot: Lessons Learned From A Bond-Unfriendly Era

Part 1: How a ‘stra-tactical’ approach can help investors stay ready for change This series uses historical economic snapshots to explore how a “stra-tactical” investment approach that combines strategic and tactical allocations can help investors manage volatility. This first blog looks at the bond-unfriendly period during the 1950s and early 1960s. Part 2 examines the bull equity markets of the 1980s and 1990s, while Part 3 looks at flows into equity and fixed income markets since the Great Recession. With prospects of continued volatility in equity and fixed income markets, maintaining a strategic allocation to assets that perform differently in various economic environments can help investors avoid having one asset class dominate portfolio performance. At the same time, investors need a stra-tactical investment approach that affords the flexibility to tactically pursue specific investment opportunities without going all-in or all-out of an asset class. This blog explores the reasons why this approach, with a meaningful allocation to bonds, may have benefited investors at certain times during the ’50s and early ’60s. Unhappy days for bonds The 1950s are commonly regarded as the worst for bond returns. In the rising interest rate environment that began in 1950 and extended through the Great Society in 1965, bonds returned around 2.0% on average, while stocks returned 16.2%. 1 Part of the reason bonds performed poorly during the period is that the absolute level from which interest rates rose at the beginning of the decade was artificially low – at or below 2.5%. 2 To maintain stability in the financial system preceding and during World War II, the Federal Reserve (the Fed) agreed to take steps that kept interest rates low, with short-term rates below 0.375% and long-term rates below 2.5%. 2 This policy ended in March 1950 when the Fed was allowed to resume an active and independent monetary policy. Long-term rates began rising from their low base of less than 2.5% shortly thereafter. By January 1960, they had nearly doubled to 4.7%. 1 When rates start at such a low base, the income on bonds isn’t sufficient to offset the capital loss from falling prices, and total return falls. Investing in bonds during a rising rate environment While this period of rising rates was clearly a hostile decade for fixed income, here are several reasons investors could have benefitted from an allocation to bonds: Stocks outperformed most of the time, but not all of the time . Bonds outperformed stocks in 1953, 1957, 1960 and 1962. 1 These years broadly corresponded with periods of economic slowdown or recession. In a rising rate environment, interest rates rise most of the time, but not necessarily all of the time. While such movements can be short-lived, they could result in portfolio underperformance. The downside for bonds, if held to maturity, is more limited than the downside of stocks. Even in the worst year (1959) of the worst decade, bonds were down 2.6%, compared with the worst year (1957) for equities, which were down 10.5%. 1 Bonds were significantly less volatile, in terms of standard deviation, than stocks (by less than half) during the period from 1950 through 1965. 1 History doesn’t repeat, but it can rhyme What does this all mean for today’s investors, who are anticipating a possible interest rate increase by the Fed in December 2015? Investors should resist the temptation to draw direct parallels between this historical period and the current interest rate environment because too many factors affect equity and fixed income market returns. But by looking to this period, investors can glean the importance of: Diversifying a portfolio by sources of economic risk rather than sources of return. A portfolio that can mitigate the unexpected risks of different macroeconomic environments may help an investor’s financial plan stay on track in any interest rate environment. Potentially reducing volatility with bonds even when rates rise. In addition to income, bonds may offer investors the benefit of lowering the volatility of portfolio returns. Instead of making investment decisions based on interest rate bets, investors need to be prepared for different economic outcomes. Talk to your advisor about a strategic portfolio allocation that includes exposure to stocks, bonds, commodities and other asset classes. Sources Federal Reserve Economic Data (FRED), “Historical Returns on Stocks Bonds and Bills – United States,” Aswath Damodran, Stern School of Business, New York University. Bonds are represented by US 10-year Treasuries; stocks are represented by the S&P 500 Index. Federal Reserve Bank of New York, “U.S. Monetary Policy and Financial Markets,” Ann-Marie Meulendyke, 1998, and University of Chicago Press, “Financial Markets and Financial Crises,” Glenn R. Hubbard, ed., January 1991. Important information Diversification does not guarantee a profit or eliminate the risk of loss. Past performance cannot guarantee future results. In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions. Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. Although bonds generally present less short-term risk and volatility than stocks, the bond market is volatile and investing in bond funds involves interest rate risk; as interest rates rise, bond prices usually fall, and vice versa. Bond funds also entail issuer and counterparty credit risk, and the risk of default. Additionally, bond funds generally involve greater inflation risk than stocks. The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals. NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. ©2016 Invesco Ltd. All rights reserved. Car hops to Camelot: Lessons learned from a bond-unfriendly era by Invesco Blog

1704 On The S&P 500 In 2016? Less Far-Fetched Than Investors Want To Believe

How does a favorable bullish uptrend become an unfavorable bearish downtrend? Does the transition happen overnight? Do commentators, analysts, money managers and market participants simultaneously concur that the environment for risk-taking is exceptionally poor? The transition from “good times” to “bad times” is far more gradual than many realize. Granted, prices on the Dow or the S&P 500 may fall apart in a matter of days, changing the narrative from “no reason to worry” to “don’t panic.” That said, there are a wide variety of indications that forewarn mindful investors six to twelve months in advance , including consecutive quarters of corporate profitability declines, economic deceleration, and waning participation in price gains across the majority of assets and asset types. 1. Corporate Profits Have Been Breaking Down For Quite Some Time . Peak profitability for the S&P 500 occurred with the third quarter results of 2014 (9/30). Operating earnings that exclude “non-recurring” charges like one-time losses and loan write-downs came in $114.5; reported, or actual earnings, came in near $106. Not only will operating earnings decline for two consecutive quarters on a year-over-year basis for 12/31/2015, but reported earnings will decline for three consecutive quarters on a year-over-year basis (i.e. Q2, Q3 and Q4 in 2015). An earnings recession – two consecutive quarters of year-over-year declines is a bad omen regardless of the earnings type that one looks at. According to one researcher, Keith McCullough, two consecutive quarters of declining profits always result in bearish price depreciation for the S&P 500 in the subsequent year. Similarly, I have pointed out in past articles that a relationship between a manufacturing recession via erosion of the Institute for Supply Management’s PMI strongly correlates with declining earnings per share (EPS). In other words, as much as cheerleaders look to play up ex-energy (EPS) or the 65%-70% service-oriented (ex-manufacturing, ex industrials, ex transports) economy, overall S&P 500 profitability weakness goes hand-in-hand with overall economic weakness. The last two bear markets tell the tale. Back in 2000, bulls continued to push the idea that consumers were resilient and forward earnings projections (ex tech) looked phenomenal. They missed the bearish turn of events entirely. Back in 2008, bulls opined that forward earnings estimates (ex financials) were attractive, and that manufacturer health was irrelevant. They missed the housing bubble as well as its subsequent bursting. Here in 2016, bulls are confident that the U.S. can shake off $30 oil, energy company stock/bond woes, a manufacturing recession and a sharp global economic slowdown without a 20% drop for the Dow or S&P 500. Unfortunately, there’s more to the story. 2. The U.S. Economy Continues To Slow And The Global Economy Is Getting Worse . In 2014, I talked about the best way to participate in a late-stage bull market. In June of 2015, I advocated lowering one’s overall allocation to riskier assets . Bearish? Cautious would be a more appropriate description for downshifting from 70% equity exposure to 50% equity exposure. One of the key reasons for reducing risk had been the consistency of the downtrend in the global manufacturing. Here is a chart of JP Morgan’s Global Manufacturing PMI that I described in numerous pieces in the summer of 2015. It should not come as a surprise that U.S. corporate earnings peaked near the top of the PMI Index level in September of 2014. Since that time, a super-strong dollar strangled profits as well as U.S. exports. Meanwhile, Fed “de facto” tightening via tapering asset purchases throughout 2014 coupled with its direction shift in overnight lending rates in late 2015 have strained gross domestic product (GDP) growth. Even worse, Russia and Brazil are fighting off nasty recessions. Japan is there as well. China’s slowdown may be accelerating. Oil producing nations are close to falling apart on $30 oil. And expectations for Europe continue to sink, as debts pile up and international trade diminishes. Indeed, it’s not difficult to spot the pattern on global nominal year-over-year GDP. When it’s negative, market-based asset prices, including those in the U.S., are more likely to deteriorate. What about the constant drumbeat that sensational U.S. job growth proves that the domestic economy is healthy? Not only are the majority of new jobs low-paying, part-time positions, but the erosion of 25-54 year-old workers from the labor force – from 83.5% in 2008 to 81% in 2016 – represents millions of non-retirees who are not being counted. What about the notion that the U.S. consumer is resilient? According to a wide range of resources, including data at Federal Reserve web sites, personal consumption expenditures (PCE) is the primary measure of consumer spending on goods and services in the U.S. economy. Some would say that PCE accounts for nearly two-thirds of domestic spending, which would make it a significant driver of economic growth. Here’s the problem. Year-over-year percent growth in PCE has been declining steadily since May-June on 2014, which is roughly in line with more significant reductions in the Federal Reserve’s asset buying program (QE3). 3. Weakness in Breadth Of U.S. Stock Market As Well As Majority Of Asset Types . By May of 2015, when the S&P 500 hit its all-time record (2130), investors had learned that reported profits had declined on a year-over-year basis – 3/31/2015 ($99.25) versus 3/31/2014 ($100.85). In the same vein, by May of 2015, investors were privy to significant deceleration in Global PMI, U.S. manufacturer woes as well as dissipating personal consumer expenditures (PCE). Yet there was more. The NYSE Advance/Decline (A/D) Line seemed to have peaked in late April. From late April through the August-September correction, the number of declining stocks outpaced the number of advancing stocks. In fact, in late July, market breadth had grown so weak, the A/D Line fell below its 200-day moving average for the first time since the euro-zone crisis – four years earlier. What’s more, less than 50% of S&P 500 stocks could claim bullish uptrends. Equally disturbing, the Industrial Select Sector SPDR ETF (NYSEARCA: XLI ), the iShares Transportation Average ETF (NYSEARCA: IYT ) as well as small caps via the iShares Russell 2000 ETF (NYSEARCA: IWM ) had already entered corrections; all had dropped below respective long-term trendlines. In other words, market breadth was extraordinarily weak. Obviously, a great many folks believed that an October snap-back rally had terminated the volatile 12% correction that occurred in the summertime. Not only did the S&P 500 fail to recover the highs from May of 2015, but virtually all asset types never made it back. And now, most of those assets are actually lower than they were at the August/September lows . Take a look at the widespread carnage that extends far beyond the S&P 500 or the Dow. U.S. small caps in the Russell 2000 (IWM) reside near 52-week lows. The same holds true for commodities via the PowerShares DB Commodity Index Tracking ETF (NYSEARCA: DBC ), Europe via the Vanguard FTSE Europe ETF (NYSEARCA: VGK ) and emerging markets via the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ). Still choose to believe that rapid deterioration across asset types as well as within U.S. stocks themselves is irrelevant? Perhaps some data from the wildly popular Bespoke Research team might provide additional perspective. Internally, the average stock in every U.S. stock classification has already fallen more than 20% from a 52-week high (through 1/11/2016), meaning the average stock is in a bear market. Think this is a mathematical slight of hand because of energy stock depreciation? Wrong again. Every stock sector with the exception of consumer stables and utilities – safer haven assets less tied to economic cycles – is down more than the 20% bear market demarcation line. Is it possible for Amazon (NASDAQ: AMZN ), Alphabet (NASDAQ: GOOG ), Facebook (NASDAQ: FB ), Microsoft (NASDAQ: MSFT ), Home Depot (NYSE: HD ) and a host of influential companies to keep market-cap weighted S&P 500 ETFs like the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) from sinking 20%? It’s possible. Is it likely? Not unless the Fed has a change of heart on the direction of its monetary policy and not without unanticipated improvements in both corporate profits and the global economic backdrop. For Gary’s latest podcast, click here . Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. 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