market update call – audio transcript october 22, 2014...oct 22, 2014 · opening: this is a...

MARKET UPDATE CALL TRANSCRIPT – October 22, 2014 Important disclosures provided on pages 14 & 15. 1

Market Update Call – Audio Transcript October 22, 2014

Speakers

Daniel Clifton John M. De Clue, CFA Terry D. Sandven Head of Policy Research Chief Investment Officer Chief Equity Strategist Strategas Research Partners The Private Client Reserve U.S. Bank Wealth Management of U.S. Bank

Opening: This is a recording of the U.S. Bank Wealth Management Market Update Call held on October 22, 2014. The discussion outlined views about potential market implications that may occur as a result of the November midterm election outcomes.

John De Clue: Hello everyone and welcome to this market update discussion, which is hosted by U.S. Bank Wealth Management. I’m John De Clue, Chief Investment Officer of the Private Client Reserve, and I want to welcome you all to the call.

Today’s call features a discussion about potential market implications that

may occur as a result of the upcoming midterm election outcomes. And I’m really delighted to have, as our special guest speaker, Dan Clifton, a partner and head of Policy Research at Strategas Research Partners. That is a group that we heavily rely on for outside and independent information research. I want to just thank them for the help they provide to us.

Dan is a highly acclaimed for this research in political analysis of the

interaction between legislation, policy and capital markets. Many of you may have seen his work since it’s been widely distributed throughout the investment community and is often cited in the media. And I might add, on a personal note, in Dan’s background he was a true Washington “insider.” So he’s really seen the comings and goings in the quarters of power.

Also joining me today is Terry Sandven, Chief Equity Strategist for U.S. Bank

Wealth Management. Throughout the call, Terry and I will participate in the conversation by asking Dan questions and providing views.

So, gentlemen, welcome and thanks for joining me on the call today.


As we head down the final stretch leading up to the midterm elections, there

seem to be a lot of moving parts impacting, or likely to impact, the financial markets. So I thought we might focus our conversation on four broad topics.

One, the importance of the midterm elections in the general sense, historically.

Two, a midterm election outlook. Three, possible policy changes resulting from a change in senate control should that occur. And then fourth and finally, the likely market impact, including a general assessment of the equity market following the recent market volatility.

Before turning to Dan for my first question, I need to remind you that the

views that Dan expresses are his own and those of Strategas and do not necessarily reflect the opinions or positions of U.S. Bank.

Dan, let’s get into it. Using history as a guide, question number one, how

would you characterize the importance of the midterm elections from a historic point of view?

Daniel Clifton: Thank you for having me today. Midterm elections, historically, have been a

very important point for public policy, for politics and, of course, for equity markets. We looked back over the last 100 years and looked at how different presidents have fared in their midterm elections. Generally, most midterm elections have not been good for the party of the incumbent president. And that’s been even more pronounced in what we call a sixth-year midterm. That means the sixth year of a president’s term, which President Obama is in right now.

And going back to 1918, so over the last 100 years, every president that’s had

a sixth-year midterm election has suffered major losses in the midterm election. The only exception to that was Bill Clinton in 1998, largely because the Republicans overreached on impeachment in 1998 and the Democrats were able to overcome that. But, if you remember, eight years ago, President Bush suffered significant losses in his sixth-year midterm election. And so, as a result, these midterms usually bring a new change in Congress for the next two years―and with that, brings a change in public policy.

Because of that expected change, you see a lot of uncertainty build ahead of

the election. Usually, that uncertainty happens in the summertime. We didn’t see as much uncertainty this time around, but we are starting to sense it over the last few weeks or so.

Once that political party changes in Congress, you usually get different types

of policy changes that impact different sectors―so like Energy and Healthcare. And then really what we find to be interesting about these midterm elections is that as soon as this election is over, a new one is going to start. My belief is that you’ll see Hillary Clinton out there already running for president, as well as the 20 or so Republican candidates that think they’re going to run for president. It’s almost as if those candidates can’t really say they’re running for president until you get through this midterm election. But,


I think it’s something that you’ll see as soon as this one is over two weeks from now.

Terry Sandven: Dan, what about fourth quarter performance in midterm election years? We

know that stocks, on average, to go back to the 1920s, have historically performed well during the fourth quarter. Of course, this year, we’re off to somewhat of a volatile fourth quarter start. But historically, October, November, December have consistently been among the better-performing months of the year. And so, of course, mindful that past performance has no assurance of future success, does the historical pattern of favorable fourth quarter performance hold true for midterm election years as well?

Daniel Clifton: That’s an excellent question. It’s actually that midterm election years are even

better for fourth quarter performance than non-midterm election years. In fact, the average fourth quarter return in a midterm election year is 8 percent on the S&P 500. In the other years, the non-midterm election years, it averages only about 4 percent in the fourth quarter.

And what’s interesting is that if you look at the way stocks have traded this

October, that’s very normal to the way stocks traded historically in midterm elections, where the first two weeks you get kind of a down market and then we usually rally into the election. Not only do we rally into the election, but we rally after the election. In the third year of the presidential cycles, which is the year that we’re going into, is the best performing of the four years in that presidential cycle.

And, what’s interesting though, and I can’t stress this enough, is that what’s

been unusual about this year is that usually we get a very large midterm election selloff in the stocks―so a large inter-year correction. The average inter-year correction in the S&P 500 is about 19 percent for the midterm election year. And this year, we’ve only hit 7.5 percent inter-year decline, which we did over the last two weeks or so. And so we may not get that strong of a rally up next year as we have in the past. But the seasonal trends have looked very familiar to previous midterm elections, just at a less exaggerated rate.

John De Clue: Hey, Dan, back to John. So that’s interesting. I don’t know whether to feel

good about that down 7 percent or not, but in the context of down 19 percent, I do feel good about it. Have you noticed any differences in performance depending on what side of the aisle wins the election or perhaps after Democratic and Republican sweeps?

Daniel Clifton: That’s an excellent question. You know, I get asked this all the time. Well, if

the Republicans take over the Senate, is that good or bad for the stock market? And what we have found is that the S&P 500 has not declined in the 12 months following a midterm election since 1946. Now, I probably jinxed it by telling you that statistic. But the point of me telling you that statistic is that stock markets have rallied whether Republicans have taken over the Congress, whether Democrats have taken over the Congress―equity markets in general do not have a partisan bias. And in fact, there are really two probable outcomes of this election.


The first outcome could be that we retain the status quo. President Obama will

still be president. The Democrats will still control the Senate. And the Republicans will control the House. Under that scenario, the average S&P 500 performance annually has been 14.1 percent.

The other option is that the Republicans take over the Senate. So President

Obama will still be president, but the Republicans will control both Chambers of Congress. And under that scenario, the average return is about 15 percent annually.

So there really is no difference between the two. And I tend to believe that

markets reward divided government, so to speak. But regardless of which party took over, there’s been no change in the performance of the S&P and it really is about getting into that presidential election.

It’s no secret that politicians love to prime the pump ahead of the election.

And in the third year before that presidential―or the third year of the cycle before the presidential election―you usually see new stimulus in the market, discounts at stimulus, and that’s where the strong performance comes from.

John De Clue: Okay. It’s John again, Dan. On that note, let’s go to our second topic―this

year’s midterm election outlook. So how would you summarize midterm elections this year? Some of the recent polling, I think, seems to indicate that this may be a year of change but what are your thoughts?

Daniel Clifton: We still got two weeks ago. I don’t underestimate it for some candidates to

make major mistakes in the final two weeks. They get tired at this point. So the chance of making mistakes are easier.

But if we look at the data―a couple of points. First, as I mentioned earlier,

presidents usually suffer large losses in their midterm election for their party. The average number of seats the president loses in their sixth-year midterm election is six. That’s how many the Republicans need to take over the Senate this time around. And more importantly, the Democrats have seats that they’re defending in states that Mitt Romney won in the 2012 presidential election. In fact, Democrats are defending seven states that Mitt Romney won. Of those seven, six of those states Mitt Romney won by 14 percent or more. So the point being that the Republicans don’t have to win swing states. They just really need to win Republican states to take over the Senate, and the polling would suggest that the Republicans are getting close to taking over the Senate. In fact, if you took all the polling today and assign the person that’s in the lead, the Republicans would pick up eight seats and they’d have 53 senators.

Now, I don’t know if that’s going to be the actual result. Some of those

elections are within the margin of error. But you could see the momentum has been with the Republicans, and really more so over the last week, which we think is a response to some of the bad coordination to the Ebola situation.


Terry Sandven: Dan, this is Terry again. So do you think that will be the outcome―that

Republicans take over the Senate? And I was thinking this morning, too, that maybe the President’s approval rating is a factor, or has a role in this process. I saw some of the recent polling data that shows that President Obama’s approval rating is 43 percent. George W. Bush during the similar time was at 39 percent and President Clinton was at 63 percent. So, you know, maybe that is a component to the process. But nonetheless, it seems that securing six, or perhaps eight seats seems to be quite a formidable task.

Daniel Clifton: Yes. There is some correlation between the president’s approval rating and the

number of seats they lose. Our research finds that it’s really in the first midterm election, not the second midterm election of the president.

But clearly, voters are down on the President. Most of the Democratic

Senators are trying to run away from the President. You know, we have a pretty sophisticated model that we operate at Strategas that has a very good record of predicting elections. What I find to be interesting is that there’s now been a proliferation of these models that are being generated by the media. In every media model for projecting the election has the Republicans picking up at least six seats, and so there’s a greater than 50 percent probability that the Republicans do win the Senate.

Now, I would say that the Republicans have to win three open seats and they

have to beat three incumbent Senators, and the Republicans have not beat three incumbent Senators in one election since 1980 on Ronald Reagan’s wave. So they would have to do something that they’ve never done before.

And I would also say that the Democrats have used a very good advantage to

them of being the incumbents by raising money. The Democrats have raised $120 million in this election. The Republicans have raised just $80 million. And I think that this election would have been sealed a lot earlier for the Republicans given the historical trends if not for the money advantage that the Democrats had. At the end of this process, the Republicans have more cash on hand and probably will have the advantage in the final two weeks there. But we generally think it’s over a 50 percent probability that the Republicans take over the Senate.

I just want to make one point before we get into some of those individual

races, and that is that we may not know who controls the Senate on election night largely because there’s going to be at least one runoff, if not two. Louisiana would be a runoff state because you need 50 percent. There are three people in that race. And Georgia―we got new polling on that today. It continually, it looks like it’s going to be a runoff state as well. So there could be some uncertainty about who’s actually going to run the Senate if the Republicans do not have a clean sweep on election night.


John De Clue: Dan, it’s John again. So what are the key races to watch over the next two

weeks? Daniel Clifton: That’s an excellent question. You know, I would start off by just saying West

Virginia, Montana and South Dakota. Those are the three Democratic seats that you have retiring members in. And so we call them open seats. The Republicans would like to win all three of those seats.

The next set of elections to watch are Arkansas, Alaska, Colorado and Iowa.

Those are elections where Democratic incumbents are running for re-election and they could possibly lose on election night. If the Republicans win those seven seats in a clean sweep, they would have, at that point, 52 seats. So there would be a lot on that side.

But there’s some problems building on the Republican side that I would pay

attention to as well and that is Kansas. Kansas is a very Republican state that has been moving against the trend of Democrats losing seats and the Republican incumbent Senator is even in the polls there. So for every seat the Republicans lose, they would have to gain another Democratic seat to get to that majority.

Kansas is number one. Georgia is number two. I mentioned that that could go

to a runoff. But it also could turn out that maybe the Republicans lose that seat. I tend to believe the Republicans are going to end up pulling out Kansas, but Georgia seems a little bit more problematic for the Republicans.

And then finally, Louisiana. Louisiana will go to a runoff. That election will

be on December 6. It will then be a two-person race. And we expect the Republicans will ultimately win that race, but we may not know it for a month after Election Day.

John De Clue: So, Dan, let’s go to Topic Number 3―potential policy changes. In recent

years, key policy issues, such as the fiscal cliff and the debt ceiling levels have been concerning to investors. From your point of view, what would be some of the key policy issues that would likely be the focus as we look towards the new year? And I suspect who controls the Senate will ultimately influence this and other policy changes. So if you’d talk about that a little bit, I appreciate it.

Daniel Clifton: Yes. So we tend to look at policy from really two perspectives. The first

perspective would be the macro policy issues―budgets, debt ceiling―very big picture type of issues. The second is then we break issues out by sector.

Let me deal with the macro issues first. The very first issue we’re going to

have to deal with this what we call the debt ceiling. If you remember, in August of 2011, we had a major fight over the debt ceiling where if we didn’t raise that debt ceiling, there was a risk that the U.S. would default on its Treasury. Ultimately, that did not happen, but it was followed by a credit downgrade from Standard & Poor’s. Then in the week after, that issue got resolved.


There is a belief building in the market that if the Republicans take over the Senate, we are going to have another major debt ceiling fight when the debt ceiling has to be raised sometime in mid-March. I think the date is March 15th. It could get pushed back if the budget data is improving. But ultimately, in the first half of 2015, we’re going to have to raise the debt ceiling.

I tend to believe that there will not be a major risk to investors from the debt

ceiling. This is my personal opinion and the opinion of Strategas, not U.S. Bank, but largely because the Republicans do not have the votes to raise

the debt ceiling without the help of Democrats. And so that means that the Republicans can’t really hold the process hostage, and the Republican leadership seem to be suggesting that they would rather have their political fights with President Obama over the budgets and how the EPA is funded, how the Affordable Care Act is funded, and less so about the debt ceiling. So I would say that we’re a little bit out of consensus in that view, but we have a very good reason why we’re out of consensus. The Republican leadership don’t really seem to believe there’s any real reason to have a major fight over the debt ceiling. It does have to go up.

That then leads into a series of budget fights and I don’t think that there’s

much risk of a government shutdown, largely because we had a government shutdown in October of 2013 and nobody wins politically in a government shutdown. I think that was a very stark reminder. We will have very, very spirited debates. Both parties will fight for the principles that matter to them and it’s going to take a while for them to get agreement, but I ultimately don’t think there’s much risk to investors.

And if you remember in the late 1990s, we had a very, very strong stock

market. We had two government shutdowns and we impeached the sitting president of the United States, and markets rallied through that.

As long as Congress is not defaulting on its Treasury debt or putting in more

austerity that could reduce GDP, then a lot of this political in-fighting will be just noise itself.

A very big positive issue that we see getting resolved, if the Republicans take

over the Senate, is something called the Trans-Pacific Partnership. This would create a system of free trade with the U.S., Canada, Mexico and all of the other Asian countries, except for China. It allows the U.S. to start selling its goods at a cheaper, lower tariff into these countries and help our international allies that’s trying to start to become a rising power to them. The Republicans want to do this. The President wants to do this. The Senate Democrats do not want to do this. And so if the Republicans take over the Senate, you see a clear path for them to actually get something done in a bipartisan compromise and I think that would surprise the markets.


Terry Sandven: Dan, on that note, let’s jump a little further ahead and look at sectors,

particularly the Energy sector. What are your thoughts regarding U.S. energy policy? You know, clearly, the U.S. renaissance that is underway is helping reduce U.S. dependence on foreign oil and clearly is contributing to keeping energy prices down. So what are the prospects for maybe more pipelines that would help in transportation or, shall we say, the likelihood that we will see a change in legislation that could allow for more exports?

Daniel Clifton: Terry, that’s an excellent question because just think about where we were

five or six years ago. We didn’t even realize that we have a lot of this energy under the ground. And today, the United States is the largest oil and gas producer in the world. By 2016, we’ll be the largest crude oil producer. We’re already the largest natural gas producer in the world. This has been a very welcome surprise.

But just because we have it under the ground does not mean that it’s ready to

go. We have to build out the infrastructure, as you rightly noted. There are a couple of key issues that I think investors should be focused on if

the Republicans take over the Senate. The first is that the pipelines within the U.S. are not getting built at a fast enough pace. I looked at a document today that said the average pipeline takes 558 days to get approved. The Republicans are signaling that they are going to pass legislation that would require the Federal Energy Regulatory Commission to approve those pipelines on a certain time frame. Maybe they have 100 days, or whatever the number is that they’re going to set. And what that does, is it speeds up the buildout of the energy infrastructure. If you remember, the northeast got very cold last winter. Sure it was cold everywhere in the country last winter. But we couldn’t get the natural gas to the homes in Massachusetts because we didn’t have the infrastructure and you saw a big spike in natural gas prices.

So just having the energy is one thing. We need a policy to improve the

infrastructure. The big issue is keystone pipeline. And we expect if the Republicans take over the Senate, you will see keystone pipeline approved one way or another, whether that’s through the President approving the permit or actually doing legislation to approve the permit. But if you look at what’s going on in the U.S. economy right now is that rails are taking oil and they’re taking sand to get the oil out of the wells. But what it’s doing is it’s backing up chemicals, coal, food. Food prices are growing at about 2.5 percent in inflation. It’s one of the few places where you actually see inflation. Part of that is because of transportation cost. And the way you fix that is you approve the keystone pipeline and take that oil off the rails and into the actual pipeline and then that will free up the rest of the distribution network. So we expect to see something on that.

The big issue is whether we’re going to wind up exporting crude as much as

we need to probably export crude oil―just because the oil that we’re making is what we call light sweet crude and the refiners can only do heavy sour crude.


I don’t really see the votes in Congress to do that right now. So we expect the President to step by step issue small rules that would allow more exports of crude and really test the markets, see how the market responds to that, so that we don’t have a big spike in oil prices. And the LNG (liquefied natural gas) exports are really on pace. And we’ll start to see those liquefied natural gas exports leaving the first terminal in January of 2016.

What all of this is doing is actually reducing the U.S. trade deficit. First, we’re

importing less oil. We’re talking about being energy independent. Eight presidents have talked about it. It’s actually finally starting to happen. And pretty soon, we’ll start exporting. That starts closing the trade deficit. And this is really the first time in 40 or 50 years where the U.S. trade deficit and budget deficit are both falling at the same time. And I think that’s very positive for the U.S. dollar and the U.S. economy.

Terry Sandven: Very good. You know, Dan, another area that we’ve been monitoring in

search of investment opportunity is this defense spending. Clearly, geopolitical tensions are at elevated levels and, in fact, you could build a case that the world is increasingly becoming a less safe place. And so whether or not that’s true, we’ve noticed that some of the share prices of companies that are defense related―and I’m thinking of companies that build jetfighters or aircraft carriers, missiles, armaments and so on and I guess you could put surveillance companies in that mix as well―but they’ve all been up fairly strong at least to the end of the third quarter.

And you compare that to the trajectory of U.S. defense spending, which still

seems to be down. And so I’m wondering if our interest in defense companies may be less timely perhaps than what the budget may imply. So do you foresee any changes in defense spending as we look into, say, 2015 and beyond?

Daniel Clifton: Yes, that’s an excellent question. You know, we had done a study several

years ago. And what we found was that defense spending, as a percentage of GDP, was almost 90 percent correlated to the outperformance of defense stocks relative to the S&P 500. And what we’ve seen over the last year or two is that defense spending has actually declined, year-over-year decline. In fact, over the last three years, defense spending is down by $100 billion. And yet, the defense stocks, after really having a very rough 2011 and 2012, have rallied very, very hard.

And what I found to be very interesting is to watch how the S&P started to top

off in the summertime and the defense stocks continue to rally through that and that’s the market looking ahead and knowing that we are going to have to increase defense spending at some point.

So I guess the point that I would make is that defense spending is likely to go

higher and it’s likely to start going higher sometime in mid-2015 when you’ll start seeing the budgets passed for 2016, really the fourth quarter of 2015, and looking forward. But some of that may already be reflected in the stocks. And Lockheed Martin gave a very cautious view in their earnings yesterday. I


haven’t seen how the other companies have done yet. But there still tends to be a caution around the levels of how high defense spending can go.

But I can tell you this that the ISIS, as I like to call them, is about six miles

from Baghdad right now. There were bombs being thrown at the U.S. green zone in Baghdad today. And to me, I think once the election is over, we’re going to start seeing a bigger push for ground troops in Iraq. And with that, there has to be higher defense spending. We’re spending about $500 million a day in Syria. And eventually, at some point, Congress is going to need to authorize that funding and the defense companies will be the beneficiary of that.

John De Clue: Hey, Dan, John again. So since we’re discussing policy changes, I think it’d

be remiss not to touch on healthcare. The Affordable Care Act has been, of course, somewhat of a lightning rod since it was made law and I suspect the jury is still out as to its overall effectiveness. So my question is, do you have any general thoughts on the act itself and whether you envision any changes in the Affordable Care Act to coverage post midterm elections?

Daniel Clifton: You know, as a starting point, we have a rule that presidents do not sign

legislation which repeal or damage previous bills with those presidents’ names on it. So in this case, Obama Care, the President is unlikely to sign major changes to Obama Care, the same way President Bush was unlikely to make changes to the Bush tax cuts per se.

I think what’s interesting if you look at President Obama on New Year’s Eve

going into 2014, he tweeted “Happy New Year. The Affordable Care Act is here to stay.” And it was a very insightful comment from the President because history shows us that as soon as subsidies start to flow to individuals, then it’s very hard to take those subsidies away. And so in terms of repeal, I don’t really believe that anybody is going to repeal the Affordable Care Act and definitely not repeal the subsidies. That’s one place where the President will fight on that. But what we will see are small tweaks to the Affordable Care Act. One place that we saw or we’re going to see action if the Republicans take over the Senate is that the Affordable Care Act included a tax on medical device companies. This was not a tax on their profits but on the gross revenue generated from a medical device company. So if a medical device company was unprofitable, they would still have to pay the tax.

There’s probably 75 to 80 Senators who support repealing that medical device

tax. And I think it will be a likely candidate for action if the Republicans do take over the Senate and the number of people who supported is so high that it would override a presidential veto.

You’re also going to see the Republicans make a push to repeal what’s called

the employer mandate. This would require employers to provide healthcare coverage to their employees. We tend to think that maybe the Republicans go after it for small businesses. And maybe the Republicans come up with a different type of plan, one that’s more barebones, what we call “aluminum”


because they’re silver, gold and platinum and we say “Okay, maybe they do an aluminum plan.” There was a story in the New York Times on Friday (October 17) that said that people can’t pay for their deductibles under the Affordable Care Act because there are so many benefits in there. Maybe you do a more barebones plan to help people pay for that.

And so, there are small changes on the margin, but really most of the changes

on healthcare won’t come until you see a new president because President Obama will do everything he can to protect his legacy on the Affordable Care Act.

John De Clue: So good. Thanks, Dan. And now, let’s turn our attention to the markets, which

seems to be a timely topic given vast market actions. So Terry, we’re going to put you under the hot lights right now. So let me ask you first, what’s your outlook for the equity market as we look towards year-end and into 2015?

Terry Sandven: Well, John, it’s been an interesting two weeks, shall we say. Obviously,

volatility has returned to the marketplace with force, and I suspect part of that is because investors are awaiting clarity on visibility and company earnings.

In fact, if you look at last week’s market action, you could sense that the

market seemed to be melting down and on Friday, Monday and Tuesday, the reverse seemed to take effect where the markets were melting up. As we speak today, we’ve got a little bit of weakness with the Dow being down 120 points at present. But our sense is that the volatility that we’re experiencing at present is more of a “pause that refreshes and resets” but not one that represents the start of a prolonged bear market. And I think at issue is the diversions between the U.S. economy and the rest of the world, particularly Europe and China, seems to be widening.

The U.S. economy continues to show varying degrees of improvement, with

revenue and profit outlooks for U.S.-focused companies remaining relatively strong. We’ve seen that with employment data, housing, certainly consumer confidence and manufacturing. They’re all showing varying degrees of improvement.

Conversely, the global economy seems to be in a soft patch, which is

presenting a headwind for U.S. multinational companies, and I think what this implies is that fourth quarter and 2015 estimates need to be revised downward and that’s the refresh and the reset process that I referenced moments ago. And I think it’s occurring right now.

By the end of this week, roughly 40 percent of the S&P 500 companies will

have reported third quarter results. And so I think that’ll set the tone for performance for the rest of the year. And again, we think the market is in the process of stabilizing and has an upward bias as we move towards the end of the year.


John De Clue: So now, you’re really going to have to drag your crystal ball out of the closet

because I’m going to ask you―I know it’s unfair, but look towards year-end and into 2015, what is your outlook for the equity market as we move through the midterm elections and into 2015.

Terry Sandven: Well, that’s one million dollar question, John. Not only are you asking but

most investors are, too. In our base cases, volatility and the next leg up is likely to be challenging. But we still have an upward bias. And we think the equity market grinds higher primarily because the fundamental backdrop, in our view, is favorable. We get there by looking at earnings. Earnings are increasing even though the rate of growth may be slowing some. Nonetheless, they still are increasing. Interest rates remain low. Inflation is restrained. Valuations have improved from recent price declines. The list of compelling alternatives to equity seems limited. And the seasonal, midterm tendencies that Dan has spoken about seem favorable for performance.

So as we look at 2015, we think equities will trend higher as well but at a

more moderate pace. We continue to believe that unlike 2013 and years prior where much of the upside in the equity market as a function of Fed-driven liquidity and higher price earnings multiple expansion, we’re currently in an earnings-driven market. To that end, an improving economy will likely drive earnings and higher earnings will likely support higher stock prices.

So, John, as we look into the new year, our preliminary outlook is for earnings

to increase in the range of 8 percent, which is slightly below historical levels but, again, primarily due to expectations for continued sluggish economic growth. We would expect the broad equity market to advance at roughly the same level, the 8 percent level, in 2015. And I’ll note that we’ll formally put our 2015 earnings estimates out, as well as our price target in another week to ten days after the bulk of third quarter companies report their earnings.

John De Clue: Great. Thanks, Terry. And, Daniel, you’re our special guest but you can’t

escape. Get your crystal ball out. What is your outlook for the equity market as we look through midterm into 2015?

Daniel Clifton: Yes, I would have to agree that equities could likely grind higher. I mean, we

talked about the midterm election effect. But we try and understand what’s driving that midterm election effect and I mentioned earlier that politicians love to prime the pump ahead of the presidential election and investors will say to me “Well, Dan, it doesn’t look like Republicans and President Obama are going to do a big stimulus package,” and that’s correct. But just by doing nothing, you see the drivers for growth going into place.

We’re removing the headwinds that have impacted the economy for the last

four or five years. Government contribution to GDP will be positive for the first time in five years in 2015. I mentioned before that the trade deficit is closing. We are beginning the process of exporting crude oil. And I think the combination of the government contribution to GDP and the trade deficits to GDP is a natural stimulus that gets done just by doing nothing.


We’ll wind up providing a backstop for GDP growth and offset some of the monetary policy coming out. Taking the baton will be fiscal policy. I worry a little bit about what’s going on overseas because we’re starting to see that we’re all interconnected. And if you got positive resolution in Russia, largely as oil prices pressure Putin, that could be a very big step up because it would get rid of some of the sanctions that are hurting the German economy right now.

John De Clue: Yes, good. Okay, Terry, coming back to you before we end on the market

discussion, are there other aspects of the equity market you’re looking at as we move into 2015? And I’ll throw the same question in a minute to you, Dan.

Terry Sandven: John, certainly, there are two aspects that stand out. One is the performance of

small-cap companies, and then secondly, dividend-paying equities. One of the surprises year to date in 2014 has been the lackluster performance of small companies. You could use the Russell 2000 as a proxy for that. It’s surprising that small companies tend to perform favorably during periods of economic growth. And so you could draw the extension to the fact that if the U.S. economy is truly improving, you would expect small companies to perform as well. So if you look at performance of the small companies, we may be at a point where the tide is starting to turn. The Russell 2000 has performed fairly well the last ten days. And if that trend continues, that might be a sign that small caps will perform well in 2015 as well. So we’re watching that group quite closely.

The second one is dividend income. We like the dividend profile of equities.

Many companies have, as you well know, strong balance sheets, including mounting cash levels and that clearly presents a favorable environment for share buybacks, acquisitions and dividend increases.

In fact, as of this morning, 38 percent of the S&P 500 companies currently are

offering dividends that are above the ten-year Treasury yield of 2.2 percent. So we think that presents investors with a wonderful income and appreciation potential environment and also an aspect of the equity market that could provide some support near current levels. So we’re watching the dividend component very closely as we move into the new year.

John De Clue: Good. Okay. Same question, other aspects of the equity market you’re focused

on as we move into next year. Daniel Clifton: Yes. I’m focused on one macro and then on the sectors. The macro issue is whether a Republican Congress brings more

brinksmanship. I say they won’t but you never know as we go deeper into 2015. So that’s something that we’re keeping our eye on, particularly around the debt ceiling fight because that’s where they can do real damage. Again, we don’t think that that’s going to be a problem but it’s something that we’re watching.


And then we’re obviously looking at the sectors that we think are going to

benefit if we do have a change in party and the Republicans control both chambers. We tend to believe that those sectors are Energy, Medical Device makers, defense spending and regional banks, as well. So to me, I think that midterm elections really are about sector changes and those are the sectors that will benefit if the Republicans do, in fact, take over the Senate.

John De Clue: Great. Thank you, Dan. So thank you, Dan, on behalf of U.S. Bank clients and all of us who work at

the bank. Thank you for your partnership and for sharing your insights and perspectives. We certainly appreciate your good work and spending time with us today.

And, Terry, thank you for great observations on this call. So as we wrap up the call, please keep in mind that the information shared by

myself and Terry related to investment solutions or strategies may not be appropriate or available to all clients. Please speak with your U.S. Bank relationship manager about your personal needs and requirements. They will be happy to discuss what we’ve talked about today in the context of where you find yourself individually.

Thank you very much for your relationship with us at U.S. Bank and for

taking time to attend the call today. And again, please contact your U.S. Bank relationship manager if you’d like more information about the topics we covered today.

Closing: Thank you for listening. We invite you to join us for future calls. Details can be obtained from your U.S. Bank relationship manager.

IMPORTANT DISCLOSURES

The information provided by Daniel Clifton represents his views and opinions and those of Strategas Research Partners. The information shared by John De Clue and Terry Sandven represents the opinion of U.S. Bank Wealth Management and does not constitute investment advice and is issued without regard to specific investment objectives or the financial situation of any particular individual. Since economic and market conditions change frequently, there can be no assurance that the trends described will continue or that the forecasts will come to pass.


These views were presented on October 22, 2014 and are subject to change at any time based upon market or other conditions. The information presented is for discussion purposes only and is not intended to serve as a recommendation or solicitation for the purchase or sale of any type of security. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. Data and research information and statistics have been gathered from a variety of sources. Strategas Research Partners is not affiliated with U.S. Bank in any way.

Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio.

Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes mentioned are unmanaged and are not available for investment. The S&P 500 Index is an unmanaged, capitalization-weighted index of 500 widely traded stocks that are considered to represent the performance of the stock market in general. The Dow Jones Industrial Average (DJIA) is the price-weighted average of 30 actively traded blue chip stocks. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index and is representative of the U.S. small capitalization securities market. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Stocks of small-capitalization companies involve substantial risk. These stocks historically have experienced greater price volatility than stocks of larger companies and may be expected to do so in the future. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investment in fixed income debt securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investment in debt securities typically decrease in value when interest rates rise. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, and the impact of adverse political or financial factors.

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