Q1 2019

WestEnd Advisors

Macroeconomic Highlights

www.westendadvisors.com · info@westendadvisors.com · (888) 500-9025

Table of Contents

WestEnd Outlook Highlights…………………………………………………..… 2

U.S. Economic Backdrop

Moderate U.S. Growth Continues Despite Market Volatility..…………….. 4

Consumer Sectors to Benefit from Continued Healthy Spending……… 5

Energy Sector Challenged by Pace of Growth and Elevated Supplies…. 6

Economy Faces Typical Cyclical Risks……………………....…………………………. 7

Economy Also Faces Risks Particular to this Cycle…………………………… 8

Markets in 2018 Defined by Low Returns Across Asset Classes…………..… 9

More Economic Challenges in ‘19, but Valuations More Attractive…… 10

International Economic Backdrop

Japan: Signs of Stabilization and Potential for Improvement.……….… 12

European Economic Picture Remains Challenged…………………..………… 13

China Rides Out the Trade Storm…………………….…………………….………… 14

Emerging Asia Offers Secular Tailwinds and Attractive Valuations….… 15

Inflation and Interest Rates

Upward Pressures on Interest Rates Remain…….………………………………. 17

Yield Curve has Flattened, but Not Yet a Signal of Recession ….…………. 18

Disclosures…………………………………………………………………………………………... 19

1

WestEnd Outlook Highlights

Global economic growth should continue in 2019, despite headwinds from tradedisputes, with positive momentum in the U.S. and mixed economic trendsinternationally.

In the U.S., positive employment and wage trends should support continued healthyconsumer spending in 2019, while strong earnings growth in 2018 and the recentmarket pullback make U.S. valuations attractive amid moderate economic growth.

We favor U.S. equity sectors benefitting from a mix of secular and cyclical tailwinds,including Information Technology, Communication Services, and Health Care; wecontinue to avoid the most economically-sensitive U.S. sectors, like Industrials andEnergy, as well as the interest rate-sensitive Utilities and Real Estate Sectors.

While European GDP growth should remain positive in 2019, major E.U. economiesare seeing growth slow in the face of structural, cyclical, and political challenges.

Asia’s economic outlook is mixed, as slow-but-improving economic trends in Japancontrast with economic deceleration in China, but Asian markets now have relativelyattractive valuations and stand to benefit as trade tensions ease.

2

U.S. Economic Backdrop

4

U.S. Economy Moves Forward Amid Financial

Market Volatility

Economic readings have remained healthyoverall even as the financial marketsexperienced a period of elevated volatility inQ4.

Consumer strength has been key to U.S.growth. We expect that Real GDP grew about2.9% in 2018.

Other broad measures of economic activityalso point to steady growth. The Decemberreading on hours worked per employeeshowed a modest increase for the month.

We see the U.S. economy on track for anotheryear of moderate growth in 2019, albeit thepace of growth will likely be down from whatwas achieved in 2018.

Source: Bureau of Economic Analysis, WestEnd Advisors

Source: Bureau of Labor Statistics, WestEnd Advisors

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Weekly Hours for All Workers

Portfolio Impact

Technology & Health Care Sectors:In a moderate growth environment, continueto emphasize U.S. sectors that benefit fromsustained cyclical and secular growthdrivers.

Industrials & Materials Sectors:Avoid sectors that typically benefit fromdynamic economic growth.

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U.S. Annual Real GDP Growth

Average Growth 2010 to 2018E: 2.2%

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Consumer Spending

Redbook Index Sales (Weekly)

Core Retail Sales (Monthly)

5

U.S. Consumer Supports Economic Fundamentals

Source U.S. Census Bureau, WestEnd Advisors

Source: U.S. Census Bureau, Redbook Research, WestEnd Advisors

Consumer spending was strong during theholiday season despite the financial marketvolatility during Q4.

Core retail sales grew over 4% year-over-year in the first two months of Q4, andweekly Redbook Sales indicate that the paceof spending may have increased further inDecember.

Income gains for individuals are near cyclicalhighs. This income growth together withnear record-low layoffs and an elevatedsavings rate should provide fuel for spendinggains in the year ahead.

Portfolio Impact

We believe continued exposure to theconsumer – a key driver of economic growth –via the Consumer Discretionary andConsumer Staples Sectors is warranted,particularly as income growth and an elevatedsense of job security among workers supportsspending growth.

 

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U.S. Savings Rate

Source: Bureau of Economic Analysis, WestEnd Advisors

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U.S. DOE Crude Oil Total Production

Spread between WTI and Breakeven Cost

United States DOE Crude Oil Total Production Data

6

Energy Sector Challenges Likely to Persist

Source: Bureau of Economic Analysis, WestEnd Advisors

Source: Bureau of Labor Statistics, WestEnd Advisors

Portfolio Impact

A low likelihood of dynamic economic growthtogether with a challenged earnings outlookand extended valuations leads us to believe therisks outweigh the opportunities in the EnergySector.

Crude oil prices fell in Q4 as oil inventoriesincreased on the back of continued oil sales byIran and increased shale production in the U.S.Prices were also hurt by global growthconcerns.

Despite the price decline of West TexasIntermediate (WTI) crude late last year, theprice for WTI remains above the averagebreakeven cost for shale producers (top chart).

This cost dynamic, together with the fact thatnew wells have even lower breakevens,indicates that it is unlikely we will see a materialdecline in shale oil production like whatoccurred in 2015 when WTI fell well below theaverage breakeven cost (bottom chart).

Thus, continued record U.S. shale productionis likely to weigh on crude oil prices andEnergy Sector earnings.

Source: Bloomberg, Rystad Energy, BTU Analytics, WestEnd Advisors

Source: U.S. Department of Energy, Rystad Energy, BTU Analytics, WestEnd Advisors

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WTI Crude Oil Price

Weighted Average U.S. Shale Oil Breakeven Cost

7

Increased Risks in 2019 vs. 2018: Typical Cyclical

Challenges

Source: U.S. Census Bureau, WestEnd Advisors

Source: Bureau of Labor Statistics, WestEnd Advisors

The economy has made significant progresssince the cyclical trough in 2009 as key areaslike auto sales and construction spendinghave improved from their lows.

As seen in prior cycles, these same areas ofthe economy often struggle as interest ratesmove higher. The 10-year Treasury yieldpulled back in Q4, but is still up 1.3percentage points from its 2016 low.

Another normal characteristic of a maturingeconomic cycle is a tight labor market, whichtypically contributes to cost pressures forbusinesses. The Employment Cost Index inits latest reading was up 2.8%, the largestannual increase since 2008.

Portfolio Impact

Progress in the U.S. economic cycle warrantsavoiding certain segments of the financialmarkets, including Energy and MaterialsSector stocks, small-cap stocks and high-yield bonds that benefit from more dynamicgrowth.

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SAA

R) U.S. Residential Construction

Residential Construction Spending

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Employment Cost Index

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8

Increased Risks in 2019 vs. 2018: Challenges

Particular to this Cycle

Source: U.S. Census Bureau, WestEnd Advisors

Source: Bloomberg, WestEnd Advisors

The trade tensions between the U.S. andChina are a risk specific to the current cycle.

We have not avoided Industrials because oftheir exposure to a trade war, but we do thinktrade concerns have weighed on businesssentiment in the second half of 2018. This hascontributed to slower business investment(top chart) and provided another headwind forIndustrials.

Another area of concern for investorsparticular to this cycle is the deceleration inafter-tax profit growth in 2019. A large portionof the shift down is attributable to the one-timebenefit of tax reform in 2018.

Still, investors have concerns when EPSgrowth slows markedly in a mature economiccycle.

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21.2%

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2013 2014 2015 2016 2017 2018E 2019E

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S&P 500 EPS Growth

Portfolio Impact

We recognize the potential for escalating tradedisputes, but we currently see the U.S. impactas limited to specific segments of theeconomy like manufacturing and agriculture.We are avoiding Industrials Sector exposuredue to the lack of strong economic growth, butit is also a sector with significant exposure tothe ongoing trade disputes.

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U.S

. Gov

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otal

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S&P 500 Total Return

S&P 500 vs U.S. Gov't/Credit Bond Index

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Low Returns Across Asset Classes Indicative of a

Maturing Cycle

Source: Bloomberg, WestEnd Advisors

Source: Bloomberg, WestEnd Advisors

Portfolio Impact

A more advanced economic cycle demandsbeing selective within both equity and fixedincome asset classes to identify attractiveinvestment opportunities.

A return of equity market volatility and weakreturns across asset classes defined marketsin 2018.

The consistency of low returns across assetclasses in 2018 was unusual – it was the firsttime in over two decades that all major assetclasses underperformed U.S. inflation.

We see the low return environment asconsistent with a maturing economic cycle.Interest rates trending higher produces lowfixed income returns, while equity investorsdigest less compelling earnings growthcompared to earlier in the cycle.

Nevertheless, we still see compellingopportunities in select areas of the financialmarkets for 2019.

Asset Class2018

Total Return Proxy IndexU.S. CPI Inflation Estimate* 2.2% CPI All Urban ConsumersU.S. T-Bills 1.8% Barclays 1-3 Mo. Treasury Bill IndexMortgage-Backed Securities 1.0% Barclays U.S. MBS IndexU.S. Treasury Bonds 0.9% Barclays U.S. Treasury IndexCorporate Bonds -2.5% Barclays U.S. Corporate Bond IndexAggricultural Commodities -3.6% BBG Agricultural Index (Spot)Precious Metals -3.8% BBG Precious Metals Index (Spot)U.S. Large-Cap Equities -4.4% S&P 500 IndexU.S. Small/Mid Cap Equities -10.0% Russell 2500 IndexInt'l Developed Market Equities -13.6% MSCI World ex-US Index (USD)Emerging Market Equities -14.5% MSCI Emerging Markets Index (USD)Energy Commodities -16.3% BBG Energy Index (Spot)Industrial Metals -20.2% BBG Industrial Metals Index (Spot)* Inflation Estimate based on year-over-year change in CPI index as of November 2018. Source: Bloomberg, WestEnd Advisors

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S&P 500 Pre-Tax Profit Growth

Average: 4.9%

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S&P 500 P/E Multiple

10

Greater Economic Challenges in 2019, but Equity

Valuations are More Attractive

Source: Bloomberg, WestEnd Advisors

Source: Bloomberg, WestEnd Advisors

Portfolio Impact

We have a positive outlook for U.S. stocks in2019. In particular, we see sectors likeInformation Technology and Communicationsas well positioned given their recent valuationdeclines and their exposure to both cyclicaland secular drivers of earnings growth.

After the U.S. equity market pullback in Q4and the S&P 500’s 21% earnings growth in2018, the 12-month forward P/E ratio for theS&P 500 Index fell to 14.5x as of December,its lowest level since 2013.

Even though there may be more economicchallenges in 2019, prospects for equitymarket returns may actually be improved in2019 compared to 2018 given the reset invaluations for sectors like InformationTechnology and Communications.

If we exclude the boost from corporate taxcuts that benefitted 2018 growth, 2019 profitgrowth is expected to be slightly above thetrend over the last five years (bottom chart).

International Economic

Backdrop

12

Source: Ministry of Finance Japan, WestEnd Advisors

Japan on Track for Positive, Albeit Slow, Growth

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Japanese Personal Income Growth

Total Cash Earnings (3-Month Avg.)

Ordinary Time Earnings

Portfolio Impact

Japanese equities, which are at a significantdiscount to U.S. stocks, now carry similarvaluations to Europe. Unlike Europe, Japan’seconomic trends have shown signs ofstabilization and there is potential for furtherimprovement.

The negative factors within Japan’s Q3 GDPreading look temporary as the economy isexpected to move past natural disasters thatweighed on growth.

Slow, positive economic growth shouldresume in Q4 and carry over to 2019. Wagegrowth illustrates these positive trends andshould support the consumer-basedeconomy (top chart).

Corporate profits also continue to improveand higher margins can offset cost pressuresfrom a tight labor market.

Another sales tax hike looms in the fall of2019, but economic impacts should be moremild than the last hike in 2014.

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Japan Corporate Profits % of Sales

Source: Ministry of Finance Japan, WestEnd Advisors

Source: Ministry of Health, Labour, and Welfare Japan, WestEnd Advisors

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OECD Leading Indicators - Europe

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European Economic Picture Remains Challenged

Portfolio Impact

An underweight of European equities iswarranted. European valuations are lowerthan a year ago, but economic data exhibitsa slowing growth trend. The risk/rewardopportunity is unattractive heading into2019 in our view.

Economic momentum in Europe has rolledover, with slowdowns coming from largereconomies like Germany. We expect EuroArea GDP growth will be positive in 2019,but slower than U.S. growth. We alsoexpect growth inconsistencies across theEA19.

Consumer spending can remain stablegiven healthy labor markets, but structuralissues persist that will likely weigh onbusiness sentiment and equity valuations.These issues include Brexit, Italy’s debtnegotiations, Germany’s leadershipuncertainty, and France’s protests.

Monetary policy uncertainty also looms asECB President Draghi steps down in Q42019.

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Germany Industrial Production

Source: Deutsche Bundesbank, WestEnd Advisors

Source: OECD, WestEnd Advisors

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China Retail Sales of Goods

Wholesale & Retail & Trade Value less Autos and GasWholesale & Retail & Trade GoodsRetail Sales of Automobiles

Asia49%

United States19%

Europe19%

South America5%

Africa, 4%Oceania, 2%

North America ex-U.S.

2%

China Exports (in USD)

14

China Rides Out the Trade Storm

China’s trade relationship with the U.S. is beingwatched closely by us and other investors.Nevertheless, for China, only 19% of exports goto the U.S. This matches exports to Europe andis less than half of what is sent to other Asiancountries, collectively. Consistent demand fromnon-U.S. trade partners can provide support toChina’s manufacturing output and exportgrowth. A weaker RMB also presents supportfor Chinese exports.

Within China, the government’s attempts toreign in excess credit growth has weighedmarginally on consumption and businessdemand. Certain goods sectors, like auto sales,have suffered and weighed on aggregateconsumption data (bottom chart). China isproviding stimulus, such as cuts to auto salestaxes that should contribute to improved growthas 2019 progresses.

Portfolio Impact

We are also closely monitoring developments inAsia. An economic slowdown in China hasoccurred, but we expect growth stabilization in2019 due to a combination of stimulus, tradeclarity, and secular tailwinds for consumption.

Source: Customs General Administration PRC, WestEnd Advisors

Source: National Bureau of Statistics, WestEnd Advisors

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Historical Sector Weights for Emerging Asia Index

Financials Sector

Information Technology Sector

15

Emerging Asia Offers Secular Tailwinds and

Attractive Valuations

Emerging Asia forward earnings multiples arebelow their historical average and reached a≈30% discount to the S&P 500 in Q3. EM Asiaoutperformed developed markets in Q4,supported by these historically low valuations.

Within EM, we favor Emerging Asian stocks inpart because Asia is less commodity-orientedthan areas such as Latin America. In fact,Technology companies have grown to over 35%of the MSCI Emerging Asia Index. Global techleaders from Asia should continue to benefitfrom cyclical consumer and business spending,as well as from secular trends includingaccelerating internet penetration, rapid adoptionof digital payments, and e-commerce growth.This exposure to secular growth drivers makesEM Asia stocks compelling at a price that is lessthan 11x forward EPS.

Portfolio Impact

Chinese and other EM Asia equity valuationsreflect overly pessimistic sentiment and riskaversion. We think stable-to-improving growthand contained trade war ramifications will pushvaluations higher and to more normal levels.

Source: Bloomberg, WestEnd Advisors

Source: Bloomberg, WestEnd Advisors

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Discount to S&p 500 (Relative Forward P/E)

MSCI Emerging Markets Index

MSCI EM Asia Index

Inflation and Interest Rates

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U.S. Hourly Earnings Growth

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CPI

Real Interest Rates

Average Level 1972 to 2018: 2.45%Average Level 1997 to 2007: 2.74%  (2% Inflation Period)

17

Interest Rates Fell in Q4 2018, But Upward

Pressures Remain

The yield on the 10-year Treasury bond declined38 bps during the fourth quarter, but is still up130 bps from the 2016 low.

A likely slower pace of interest rate hikes by theFed along with worries about trade and growthcontributed to the recent decline in interest rates.

Factors remain that are likely to push interestrates higher. Real interest rates remain low, forexample. Inflation has moved above 2%, yet the10-year Treasury yield’s premium over inflation iswell below the long-term average (top chart).

Another source of upward pressure on interestrates is the increase in hourly wages. The gainsin wages amid subdued productivity gains isleading to cost pressures for businesses.

Source: Bureau of Labor Statistics, WestEnd Advisors

Source: Bloomberg, WestEnd Advisors

Portfolio Impact

Fixed Income: Emphasize short-durationsecurities. Exposure to investment-grade floatingrate securities and TIPS are warranted.

Equities: Continue avoiding sectors mostnegatively impacted by rising rates, like Utilitiesand Real Estate.

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Yield Curve and Recession Timing

Recession Yield Curve Inversion 10-Year minus 2-Year Treaury Yield

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Yield Curve has Flattened, but Not Yet a Signal of

Recession

We continue to monitor closely the spread between 2-year and 10-yearTreasury bond yields. We believe recent investor and media concerns overthe potential for a yield curve inversion are premature, not only becauseinversion has yet to occur, but also because inversion of the yield curve hashistorically been a leading, rather than a coincident indicator of recession.

Over the past five economic cycles, there has been an average of over 20months from the time the curve first inverts to the start of a recession.

In our view, the current positive yield curve, though much flatter than a yearago, is more indicative of a late-cycle expansion with room to run than of animpending recession or extended bear market.

Source: Bloomberg, WestEnd Advisors

Portfolio Impact

We expect the recentpullback in interest rates willreverse as investors’concerns over economicgrowth abate. Higher short-term interest rates and a morepositive equity market outlookin general should benefit theFinancials sector.

This report should not be relied upon as investment advice or recommendations, and is not intended to predict theperformance of any investment. Past performance is not indicative of future results. It should not be assumed thatrecommendations made in the future will be profitable. The information contained herein is not intended to be an offerto provide investment advisory services. Such an offer may only be made if accompanied by WestEnd Advisors’ SECForm ADV Part 2. These opinions may change at anytime without prior notice. All investments carry a certain degreeof risk including the possible loss of principal, and an investment should be made with an understanding of the risksinvolved with owning a particular security or asset class. The information has been gathered from sources believed tobe reliable, however data is not guaranteed.

The Standard and Poor’s 500 Stock Index includes 500 stocks and is a common measure of the performance of theoverall U.S. stock market. The MSCI ACWI consists of 47 country indexes comprising 23 developed and 24 emergingmarket country indexes. The total return of the MSCI ACWI (Net) Index is calculated using net dividends. Net totalreturn reflects the reinvestment of dividends after the deduction of withholding taxes, using (for international indices) atax rate applicable to non-resident institutional investors who do not benefit from double taxation treaties. The MSCIEurope Index represents a subset of the MSCI ACWI, comprising 15 developed market country indexes in Europe. Anindex is unmanaged and is not available for direct investment.

Any portfolio characteristics, including position sizes and sector allocations, among others, are generally averagesand are for illustrative purposes only and do not reflect the investments of an actual portfolio unless otherwise noted.The investment guidelines of an actual portfolio may permit or restrict investments that are materially different in size,nature, and risk from those shown. The investment processes, research processes, or risk processes shown hereinare for informational purposes to demonstrate an overview of the process. Such processes may differ by product,client mandate, or market conditions. Portfolios that are concentrated in a specific sector or industry may be subjectto a higher degree of market risk than a portfolio whose investments are more diversified.

Holdings, Sector Weightings, and Portfolio Characteristics were current as of the date specified in this presentation.The listing of particular securities should not be considered a recommendation to purchase or sell these securities.While these securities were among WestEnd Advisors’ strategies’ holdings at the time this material was assembled,holdings will change over time. There can be no assurance that the securities remain in the portfolio or that othersecurities have not been purchased. It should not be assumed that recommendations made in the future will beprofitable or will equal the performance of the securities presently in the portfolio. Individual clients’ portfolios mayvary. Upon request, WestEnd Advisors will provide a list of all recommendations for the prior year.

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The Bloomberg Barclays US Treasury Bill Index tracks the market for Treasury bills issued by the US government. TheBloomberg Barclays US Mortgage Backed Securities (MBS) Index tracks agency mortgage-backed pass-throughsecurities (both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and FreddieMac (FHLMC). The Bloomberg Barclays US Treasury Index measures US dollar-denominated, fixed-rate, nominaldebt issued by the US Treasury. The Bloomberg Barclays US Corporate Bond Index measures the investment grade,fixed-rate, taxable corporate bond market. The Bloomberg Agriculture Spot Index measures the price movements ofagricultural commodities included in the Bloomberg Commodity Index and select sub-indexes. The BloombergPrecious Metals Spot Subindex measures the price movements of Precious Metals included in the BloombergCommodity Index and select sub-indexes. The Russell 2500 Index is composed of the smallest 2500 securities in theRussell 3000 Index. The Russell 2500 is constructed to provide a comprehensive and unbiased barometer for thesmall to mid-cap segment of the U.S. equity universe. The MSCI World ex-USA Index captures large and mid-caprepresentation across 22 of 23 Developed Markets (DM) countries excluding the United States. The MSCI EM(Emerging Markets) Index is a free-float weighted equity index that captures large and mid cap representation across24 Emerging Markets (EM) countries. The Bloomberg Energy Spot Subindex measures the price movements ofEnergy included in the Bloomberg Commodity Index and select sub-indexes. The Bloomberg Industrial Metals SpotSubindex measures the price movements of Industrial Metals included in the Bloomberg Commodity Index andselect sub-indexes.

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