Presented by:
October 2017
Leo Grohowski Chief Investment Officer
CIO Update: Economy, Financial Markets and Investment Strategy
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• Global growth improving and more synchronized
• U.S. economy expected to deliver 2.2% real GDP this year, and 2.5% in 2018
• Low inflation and slow global growth should enable central banks to be more patient in
withdrawing accommodation
• Many of our 2017 market themes are playing out, including recent move higher in rates
and shift from monetary to fiscal policy
• Global equities remain resilient, shrugging off geopolitical risk, disasters and Washington
tensions. S&P 500 forecast of 2,700-2,800 for year-end 2018
• Fixed income remains important source of diversification and income. 10-year Treasury
yield: year-end range of 2.5%-2.75% for 2017, 2.75%-3.0% for 2018.
• Resist temptation to extrapolate returns or period of market calm. Consider rebalancing
portfolios, diversifiers and customized hedging strategies to help buffer market swings.
Key Takeaways
Uncharacteristic Market Bounce Following Trump Victory S&P 500 PRICE PERFORMANCE FOLLOWING PRESIDENTIAL ELECTIONS
*As of 5/31/17. Source: StrategasRP; Morningstar Direct 3
0.8%
-1.1% -2.3% -1.9%
-0.5%
4.1%
11.5%
0.4% 1.1%
1.9%
5.0% 4.6%
12.1%
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
14%
Election Day 1 Day After 1 Week After 1 Month After Year End 6 Months After 1 Year After
PER
CEN
T
Avg. 1984-2012 2016
Historical Bull Markets S&P 500 1928 TO PRESENT
As of 9/30/2017. Source: StrategasRP 4
Volatility VIX: FEAR GAUGE HITS 23-YEAR LOW
Data from 1/2/90 through 9/28/17. Source: FactSet 5
90 92 94 96 98 00 02 04 06 08 10 12 14 160
10
20
30
40
50
60
70
80
90
20-YEARMEAN
CBOE Volatility Index - Price
IND
EX L
EVEL
As of 9/30/17. Source: Institute for Supply Management and FactSet 6
Moderate U.S. Growth Expectations BNY MELLON WEALTH MANAGEMENT GDP ESTIMATES
-0.3
-2.8
2.5
1.9 2.3 2.2 2.4 2.4
1.6
2.2 2.5
-4
-2
0
2
4
08 09 10 11 12 13 14 15 16 17E 18E
PER
CEN
T
Real GDP
Improving Confidence
*As of 9/29/17. Sources: National Federation of Independent Businesses and Ned Davis Research; FactSet **As of 9/29/17. Shaded areas represent periods of U.S. recession. Source: The Conference Board; FactSet 7
78 82 86 90 94 98 02 06 10 14
80
85
90
95
100
105
110
IND
EX
NFIB Index ofSmall Business Optimism*
71 77 82 87 92 97 02 07 12 1720
40
60
80
100
120
140
160
IND
EX
Conference Board'sConsumer Confidence Index**
Improvement in Employment UNEMPLOYMENT RATE, SEASONALLY ADJUSTED
As of 9/30/17. Sources: Bureau of Labor Statistics and FactSet. *Includes officially unemployed, those who want a job but stopped looking, and those who need full-time jobs but can only find part-time work, measured as a percentage of the civilian labor force plus all the marginally attached workers. 8
Jan-77 Jan-80 Jan-83 Jan-86 Jan-89 Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13 Jan-16
4
6
8
10
12
14
16
18
4.20
8.30
U.S. Civilian Unemployment Rate U.S. Broader Unemployment Rate*
Housing Market
*As of 8/31/2017. July data. Source: FactSet **As of 8/31/2017. July data. Source: FactSet 9
3
4
5
6
7
8
9
10
11
12
MO
NTH
S
Months' Supply Existing Homes*
Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16-20
-15
-10
-5
0
5
10
15
20
PE
RC
EN
T
Median Price of Existing Homes - Percent Change from Year Ago**
Global Outlook REAL GROSS DOMESTIC PRODUCT (GDP)
As of July 2017. Source: International Monetary Fund 10
1.6 1.8
1.0
1.8
6.7
3.8
-1.0
2.1 1.7
1.3
1.9
6.7
2.3
1.0
2.1
1.5
0.6
1.7
6.4
3.2
1.9
-1
0
1
2
3
4
5
6
7
8
U.S. U.K. Japan EuroArea
China Middle Eastand
North Africa
LatinAmerica
PER
CEN
T
2016 2017E 2018E
Developed Markets Emerging Markets
Global Interest Rates 10-YEAR TREASURY NOTE YIELDS
As of 9/28/17. Source: FactSet 11
2015 2016 2017-0.5
0
0.5
1
1.5
2
2.5
3
PE
RC
EN
T
0.07
0.48
0.77
1.37
1.62
2.122.31
US Italy Spain UK France Germany Japan
Expect Gradual Rise in U.S. Rates
-6
-4
-2
0
2
4
6
8
10
12
14
16
18
20
2015 2016 2017 YTD
MODERATE RETURNS GOING FORWARD
12 As of 9/29/2017. Source: Barclays Capital.
Assumes current breakeven inflation of +1.8419%. Breakeven inflation impacts the total return of TIPS. As of 9/29/2017. For illustrative purposes only. Source: Bloomberg L.P.
PE
RC
EN
T
Bond Sector Returns
1.5
-1.2
-4.1 -5.3
-14.1 -16
-14
-12
-10
-8
-6
-4
-2
0
2
4
2-YearTreasury
5-YearTreasury
10-YearTreasury
10-YearTIPS*
30-YearTreasury
1-Year Total Returns with 1% Rise in Interest Rates
PE
RC
EN
T
Muni Yields as a Percentage of Treasuries
80
100
120
140
2012 2013 2014 2015 2016 2017
PER
CEN
T AAA 10-YR MUNICIPAL BOND YIELDS AS PERCENTAGE OF 10-YR TREASURY YIELDS
As of 9/29/2017. Source: Bloomberg 13
PE
RC
EN
T
'10 '11 '12 '13 '14 '15 '16 '170
0.5
1
1.5
2
2.5
3
3.5
4
4.5
PE
RC
EN
T
2.34
Rates and The Fed 10-YEAR U.S. TREASURY YIELD
14
End of QE1
End of QE2
End of ‘Operation
Twist’
Start of QE3
Taper
End of QE3
2013 ‘Taper Tantrum’
As of 9/28/2017. Source: FactSet and The Wall Street Journal.
Three-month period following tightening
Balance Sheet
Reduction Plan
Announced
PER
CEN
T
15
85.2 87.7
22.6
41.8
2.8
63.8
0.8
63.8
0
10
20
30
40
50
60
70
80
90
100
November December
Beginning of 2017 After FOMC June Meeting After FOMC September Meeting Current
Probability of December Rate Hike Spikes
As of 9/27/2017. Source: Bloomberg.
PER
CEN
T
Yield on 10-Year Treasury Note Less 10-Year TIPS
PER
CEN
T Break-Even Inflation Rate
2.66
1.20
1.85
1.0
1.5
2.0
2.5
3.0
2011 2012 2013 2014 2015 2016 2017
ROLLING IMPLIED INFLATION ON 10-YEAR TREASURY
As of 9/29/2017. Source: Bloomberg 16
PER
CEN
T
Low Inflation Supportive of Current Valuations S&P 500 P/E BY YEAR-OVER-YEAR PERCENT CHANGE IN CPI TRANCHE
As of 9/30/2017. Updated Quarterly. 1950 – December 2016. S&P 500 P/E for trailing twelve months. Source: StrategasRP. 17
16.8x 18.1x
17.3x
14.7x
10.9x 9.5x
8.3x
0
5
10
15
20
< 0% 0-2% 2-4% 4-6% 6-8% 8-10% > 10%
S&P
500
TTM
P/E
RAT
IO
INFLATION RATE
S&P 500 Operating Earnings Estimates CONSISTENT WITH SLOW GROWTH SCENARIO
As of 6/30/17. Source: FactSet, S&P 500 Calendar Year Bottom-Up EPS Estimate Source: BNY Mellon Wealth Management. 18
81.8
71.4
59.3
83.1
94.9 102.4
108.4 116.8 118.0 117
125-130 135-140
0
20
40
60
80
100
120
140
160
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017E 2018E
DO
LLAR
S
Earnings Growth Gaining Momentum NEXT 12 MONTHS YEAR-OVER-YEAR EARNINGS GROWTH ESTIMATE
Source: Bloomberg As of 9/21/2017. Earnings growth estimates in local currency. 19
15.77
11.55
10.23 10.62
0
2
4
6
8
10
12
14
16
18
MSCI Emerging Markets STOXX 600 MSCI EAFE S&P 500
PER
CEN
T
Recent Dollar Weakness Unlikely to Continue TRADE-WEIGHTED DOLLAR
Data represents the Federal Reserve Board Trade Weighted Dollar Index. As of 10/5/17. Source: Federal Reserve 20
'06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '1790
95
100
105
110
115
120
125
130
PR
ICE
LEV
EL
AVE = 109.48
AVE = 104.72
AVE = 100.06
AVE = 105.57
AVE = 101.79
AVE = 98.02
AVE = 99.58
AVE = 100.57
AVE = 103.43
AVE = 114.31
AVE = 122.09
PRIC
E LE
VEL
Tax Reform Coming? TAX PROPOSAL HIGHLIGHTS COMPARED TO CURRENT LAW
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Tax Item Current Law White House & Republican House Proposal1 (September 2017)
Corporate Tax Rate Top rate of 35% Top rate of 20%
Partnership & Other Pass-Through Entities Taxed at individual rates Top rate of 25%
Individual Ordinary Income Tax Rate 7 brackets: 10%-39.6% (+3.8% NIIT) 3 brackets: 12%/25%/35%2 (+3.8% NIIT)
Taxable Interest Income Taxed as ordinary income Not addressed3
Long-Term Capital Gains & Qualified Dividends 3 brackets: 0%/15%/20% (+3.8% NIIT) Not addressed3
Short-Term Capital Gains Taxed as ordinary income Not addressed
Carried Interest Taxed at capital gains rates Not addressed
AMT Remain Eliminated
Standard Deduction Single: $6,350 (2017) Joint: $12,700 (2017)
Single (no children): $12,0004
Head of Household: not addressed4 Joint: $24,0004
Itemized Deductions Various Eliminate all except mortgage interest and charitable contributions
Estate/Gift Tax Top rate: 40% Exemption: $5,490,000 (2017)
Eliminate estate and GST tax Silent on basis step-up and gift tax
1 Source: “Unified Framework for Fixing Our Broken Tax Code:, https://www.treasury.gov/press-center/press-releases/Documents/Tax-Framework.pdf 2 The proposal leaves open the possibility of a fourth bracket on the highest-income taxpayers. 3 The initial Republican House proposal called for investment income to be taxed as ordinary income with families and individuals able to deduct 50% of their net capital gains, dividends, and interest income, leading to basic rates of 6%, 12.5%, and 17.5% on such investment income depending on the individual’s tax bracket. 4 Personal Exemption eliminated.
Planning During Uncertain Times A PLAN FOR HIGH-NET WORTH INDIVIDUALS
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Stay the Course on Estate Planning
Consider Accelerating Charitable Gifts
Build Flexibility Into Plans
Look Beyond Tax Considerations
Don’t Stop Planning
Source: BNY Mellon Wealth Management
Our Key Investment Themes
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Moderately Rising Rates
Modest Equity Gains
Shift to Fiscal
Reform
Strong Dollar
Bouts of Volatility
Disinflation to Reflation
SUSTAINABLE ECONOMIC GROWTH
Asset Class Positioning
Underweight Small
Underweight Neutral Small
Overweight Overweight
EQUITY Large Cap Mid Cap Small Cap International Developed Large Cap International Developed Small Cap Emerging Markets Private Equity Private Equity-Real Estate
FIXED INCOME Treasuries Investment-grade Corporate Tax-exempt High Yield
DIVERSIFIERS Real Estate (REITs) Long/Short Hedge Absolute Return Hedge Managed Futures Commodities
As of 9/13/17 24
INVESTMENT STRATEGY COMMITTEE RECOMMENDATIONS
Thank You – Questions and Answers
Leo P. Grohowski Executive Vice President Chief Investment Officer BNY Mellon Wealth Management
Education Bachelor’s degree, Drew University Master of Business Administration,
New York University’s Stern School of Business
Community Involvement Board of Trustees and Investment Committee Chair,
Drew University Board member and Vice Chair, Far Hills Country Day School
Executive Responsibilities
Member, BNY Mellon’s Operating Committee Benefits Investment Committee
Chair, Wealth Management Investment Policy Committee Member, Compliance, Ethics and Conflicts Committee
Member, Investment Ethics Council
Leo Grohowski is chief investment officer of BNY Mellon Wealth Management. He leads all investment strategy and investment management functions for the wealth management organization. Mr. Grohowski joined BNY Mellon in 2007 and has more than 30 years of industry experience. Previously, he was with US Trust, Bank of America, where he was chief investment officer, responsible for investment solutions and the end-to-end investment process, including portfolio management and investment strategy for Private Wealth Management clients. Prior to his role at US Trust, he was the chief investment officer for Deutsche Bank in the Americas, overseeing more than $250 billion in assets. From 1999 to 2002, Mr. Grohowski was chief investment officer of Deutsche Bank Private Banking, serving as chairman of the Global Markets Strategy Committee and Domestic Investment Strategy group, and head of Investment Products and Services for the DB Alex Brown unit. In 1996, Mr. Grohowski joined Bankers Trust where he served as a senior trust investment officer of the Private Bank and head of the U.S. Investment Strategy group. He was with HSBC Asset Management from 1988 to 1996 and was named chief investment officer in 1993, after heading the U.S. Equities group from 1988 to 1993.
Executive Management Profile
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Disclosure Appendix
The information provided is for illustrative/educational purposes only. All investment strategies referenced in this material come with investment risks, including loss of value and/or loss of anticipated income. Past performance does not guarantee future results. No investment strategy or risk management technique can guarantee returns in any market environment. This material is not intended to constitute legal, tax, investment or financial advice. Effort has been made to ensure that the material presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of the law in any area or of all of the tax, investment or financial options available. The information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation. BNY Mellon Wealth Management may refer clients to certain of its affiliated offering expertise, products and services which may be of interest to the client. Use of an affiliate after such a referral remains the sole decision of the client. Strategic Architecture is a service mark owned by The Bank of New York Mellon Corporation. BNY Mellon Wealth Management conducts business through various operating subsidiaries of The Bank of New York Mellon Corporation. ©2017 The Bank of New York Mellon Corporation. All rights reserved.
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