Lsa 2016 market outlook

2016 LSA Market Outlook 1
These views represent the opinion of the Asset Allocation Committee and are informed by subjective assessment of the relative
attractiveness of asset classes and subclasses over a 6- to 18-month time horizon. The approach is largely qualitative and valuation
based, with attention to a broad scope of potential risks and potential return scenarios.
• Fixed Income: tightening cycle arrives
– Long-awaited Fed tightening likely t put steady upward pressure on short-term yields.
– Longer-term yields remain below equilibrium, and real yields should rise, but subdued inflation and central bank buying
provide some offset.
– Credit spreads look wide relative to favorable U.S. economic circumstances. Exposures to High Yield have to potential to
capture potential spread narrowing.
• U.S. Equity: still in mid-cycle
– Consumer spending has led to a recent pick up in U.S. growth.
– The economy remains n the middle of its current expansion, with limited recession risk.
– With the oil price fall mostly behind us, earning growth should improve.
• International Equity: European rebound continues, EM challenges remain
– Euro area equities have held up against political risk and should benefit from improvements in corporate earnings.
– Uncertainty surrounds the Japanese economic outlook, but improved corporate governance should boost stocks.
– EM economies are facing challenges on a number of fronts, including Fed tightening, commodity price weakness and a
slowdown n China.
What you’ll find

2016 Probability Outlook
• We Remain Cautiously Bullish (since 2010)
– Probability of a deep double dip recession (5%)
– Probability of a pullback around 10-15% (50%)
– Probability of Sideways moving market “Range Bound” (40%)
– Probability of continued Bull Run above 19,000 (5%)
• We believe that the return of volatility will keep the markets guessing in
2016 creating more of a sideways market. Historically sideways markets
have proven well for active management creating some favoritism to
actively managed investments. The decline in oil prices is a concern for a
possibility of defaults, and the continued restructuring of China will
continue to cause unease in the markets in 2016.
• Domestic Equity – target return for 2016 mid single digit returns. (4% - 8%)
• Fixed Income – targeted 10-yr 2.75% – 3.00%
• International Equity – mid to high single digit returns (6% - 9%)

A Broad Outlook at 2016
• Fixed Income:
• Domestic Equities:
• International Equities:
Bearish Neutral Bullish
A bearish reading indicates the potential for an asset to underperform its class or subclass on a risk-adjusted basis. A bullish reading indicates the
potential for an asset to outperform its class or subclass on a risk-adjusted basis. A neutral reading indicates the potential for performance in line
with the asset’s historical averages. The arrow represents our 12-18 month view .

Fixed Income: tightening cycle arrives
Themes:
• Low yields among high-quality investments –
average yield across developed market 10-year
government bonds is 1.4%
• Competing forces are creating a tug of war on
rates – competing pressures will likely result in
a flatter yield curve
• High yield remain attractive in the context of
an improving economy – with the U.S.
economy improving and the Fed preparing to
begin tightening, high yield is one of the most
attractive options.
• Emerging Market fundamentals are weakening
– percentage of EM investment-grade
sovereign debt has fallen to 57% form 68% in
2014
Fixed Income
U.S. Government
U.S. Investment Grade
Non-U.S. Developed
Emerging Market debt
(USD)
U.S. High Yield
Bank Loans
U.S. TIPS
Today’s environment of low yields and tight corporate
spreads offers little opportunity beyond clipping coupons.
Active management and mobility will help investors find
value in 2016

Low yields among high-quality investments 1.4%
Average yield across developed-
market 10-year government
bonds.

The Fed has anchored the short end and rates may stay lower
longer
Our team continues
to believe that we
will see the 10-year
continue to
normalize over the
next 2-5 years
pushing the 10-year
rate around 4.2 –
4.5%

High yield remains attractive in the context of an improving
economy

High yield remains attractive in the context of an improving
economy
Credit markets are experiencing reduced liquidity, in part due to outflows from mutual funds and ETFs. Extended declines in raw material
prices, including oil, has created considerable stress in those particular sectors.
We view this as an opportunity for long-term investors. Liquidity is draining and high yield prices are off. This is our view, one of the
better opportunities since 2008 to buy into well researched high yield positions. Barclays HY Yield to Worst is back to 8.71% with spreads
over treasury's at 600 basis points. The index yield is at its highest level since the fall of 2011 and is well above long term averages.
Furthermore, the High Yield risk premium (accounting for projected default losses) still looks attractive to us for this stage of the credit
cycle.
• Business fundamentals drive results for both HY and Equities
• HY Bonds typically provides much better downside protection than equities
– HY has a known terminal value you can count on
– After accounting for maturities, tenders and callable bonds the HY market typically returns approximately 18-22% of its value
each year in cash.
• Peak to trough losses of over 5% (11 in the last 25 years):
– Have been recovered in as little as 2 months, and on average about 6 months.
• After a market bottom, HY tends to reclaim prior highs in less than a year
– Only once did it take more than a year:
• § An investment at the peak in June 2007 took 24 months to return to the prior peak (after the 5% loss from June to
July).

Looking Forward – Fixed Income
We are looking to continue to overweigh credit in high yield and bank loans amid liquidity
and default concerns that could come into play in 2016. The high yield sector continues to
offer a yield advantage and lower duration profile that is less sensitive to rising interest
rates. Continued strength in M&A activity could be supportive of select issuers.
Although the covenant terms in recent issuances have become less favorable to investors,
high yield bonds remain attractive relative to other sectors in this low-yield environment,
particularly given prospects for a slowly improving economy. Many high yield issuers have
improved their liquidity profile by extending maturities and refinancing to lower-coupon
debt. Default rates remain low, and the tendency for high yield debt to be less sensitive to
changes in interest rates has appeal given that the general level of interest rates remains
low from a historical perspective.
EM bonds are facing economic headwinds, most notably from China. This has caused
several rating downgrades within EMD countries in 2015. Emerging-market fundamentals
have disappointed for longer than expected and with the US beginning to raise rates many
investors are wary.
The U.S. dollar is supported by prospects for improving growth and the potential for
higher rates in the U.S. as the Federal Reserve’s tapering program concluded October 31st
and U.S. interest rate policy normalization begins. Further policy actions by the European
Central Bank (ECB) and Bank of Japan (BOJ) to stimulate growth and inflation could
provide catalyst for their currencies to decline relative to the dollar.
Cast a wider net for income
while carefully balancing
the trade-offs between
yield and duration risk.
Use core bonds for
diversification benefits and
potential protection from
unforeseen shocks to
equity markets.
Consider a flexible strategy
with the ability to actively
manage duration.
Insight: With interest rates
likely to continue to rise in
the United States in 2016,
fixed income investors
continue to face significant
challenges.

Looking Forward – Fixed Income
2016 Order of Attractiveness
• High Yield
• Bank Loans
• World Bond
• Multi-Sector Bond
• Intermediate/Short Term Bonds
• Municipal Bonds
• Treasury Inflation Protected
Securities
• MBS/CMBS/ABS
• U.S. Treasuries
• EM Debt

U.S. Equity: improving economy and high valuations have
markets at a crossroad
Themes:
• The U.S expansion continues to mature – 69 consecutive
months of positive leading indicators.
• As rates rise, expect volatility and opportunities, but not
a recession – average annual return on stocks is 11%
during the past four tightening cycles.
• Macro factors point to select opportunities – there is a
negative correlation of consumer discretionary stocks to
commodity prices over the past 10 years.
• Valuations still suggest more muted returns – since
1954, P/E ratios of 17x have led to 4% price returns on
average over the subsequent decade.
U.S. Equity
U.S. Large Cap
U.S. Growth
U.S. Value
U.S. Small Cap
At this stage of the recovery, multiple expansion may have run its
course, suggesting that companies must deliver earnings growth for
the market to continue it’s advance. Earnings growth is attainable if
economic activity continues to be strong over the next couple of
years.

The U.S. expansion continues to mature

Equities: Is the recessionary writing on the wall? A historical
look-back at recessionary indicators

Valuations still suggest sluggish returns

Looking Forward: Domestic Equities
Active management will
play a bigger role in 2016.
In 2015 only 10 stocks in
the S&P 500 were in
positive territory and many
stocks experienced a bear
market in the 3Q pullback.
Stay focused on more
attractive valuation areas
that could potentially
dampen the impact of
increased volatility.
Insight: Although markets
should be more volatile in
2016, the United States
remains the strongest
economy in the developed
world.
We continue to remain cautiously bullish on U.S. stocks. However sluggish earnings
growth, elevated margins, and high P/E multiples leave little room for upside. We are
forecasting continued elevated volatility based on the Fed continuing to tighten and
limited upside.
An accelerating U.S. economy is a notable exception in a world where growth is expected
to be below the long-term trend for most countries. We anticipate GDP growth in the
area of 2.25% to 2.75% in 2016.
• Large Caps
– Growth valuations are slightly more
attractive than value
• Mid Caps
• Small Caps

The energy crisis is struggling to find a reliable bottom

Looking Forward Sectors
• Technology
• Financials
• Global Real Estate
• Healthcare
• Consumer Discretionary
• Energy
• Industrials
• Materials
• Utilities
• Consumer Staples
• Telecommunications
• Themes:
• We continue to like the technology , global real estate,
healthcare and financials sectors. With the U.S.
economy rebounding and Fed policy normalization
approaching, we prefer cyclical sectors that are still
reasonably valued and are geared toward benefiting
from a pick-up in global growth and lower energy
prices.
• We continue to be concerned with the energy sector.
While we still like global integrated oil companies for
their attractive valuations and diversified business
models, we are becoming more cautious toward
exploration and production companies as well as oil
servicing companies given that they are more
sensitive to any further downward pressure on oil
prices.
• We continue to be cautious on defensive and certain
dividend-rich sectors, particularly consumer staples
and U.S. utilities. These sectors all sport aggressive
valuations and carry hidden duration risk, or interest
rate sensitivity. If bond yields increase even
moderately in 2016, these equity sectors are likely to
underperform.

International Equity: the road to recovery has begun
Themes:
• QE in Europe and Japan could boost stock returns – the
European Central Bank and Bank of Japan could inflate
their balance sheets by more than $1T in coming years.
• EU sentiment, credit flows and GDP, moving in the right
direction – economic sentiment has risen to a level not
seen since 2010.
• Abenomics bodes well for Japanese equities – reforms
are shifting to investor returns: profit margins are on the
rise.
• Opposing forces in China suggest a neutral stance –
slowing growth and unpredictable policy moves temper
China’s appeal for many investors.
International
Equity
Overall Developed-
Market (ex-U.S.) equity
Japanese Equity
Emerging Market
Equity
European Equity
Relative to the United States, select foreign markets continue to offer
compelling valuations and earnings growth potential, through an
accommodative monetary policy. Emerging-market fundamentals are
stabilizing as more institutional investors are looking overseas for 2016
but we believe EM will continue to be volatile.

QE in Europe and Japan could boost stock returns – “Central bank policies in
Europe and Japan have gone from meet to aggressive. The intent is to weaken currencies, spark inflation, and
induce risk taking, which should support equities, in bot developed and emerging markets.”

International Rates

China continues to adjust the Yuan

Chinese equities present opportunities and risks “Supportive monetary
policies are helping to offset slower economic growth and unexpected policy moves”

Looking Forward: International Equities
It may be time to consider
getting back to a greater
emerging market exposure
but we should remain
selective.
Use an active manager
approach with strong
selection expertise. Allow
value managers time to
allow value calls to be
realized.
Insight: Europe has
intriguing pockets of value,
while Japan appears
relatively undervalued in
the world today
Our global growth expectations remain modest over the next several quarters. Gradual
improvement in U.S. economic activity is supported by diminishing fiscal headwinds,
increased state & local government spending, improving private sector demand and
moderate job growth. Offsetting this growth, Japanese and European growth momentum
has moderated recently with Europe remaining hindered by high debt loads, high
unemployment, and deflation worries. Slowing growth in China, Brazil, and other
emerging economies weighs on global trade as commodity prices continue to apply
pressure across the globe.
• Global/World Stock
• Developed Markets
– Foreign Large
– Foreign Small/Mid
• Eurozone
• Japan
• Emerging Markets
– Region specific
• India

2016 Probability Outlook
• We Remain Cautiously Bullish (since 2010)
– Probability of a deep double dip recession (5%)
– Probability of a pullback around 10-15% (50%)
– Probability of Sideways moving market “Range Bound” (40%)
– Probability of continued Bull Run above 19,000 (5%)
• We believe that the return of volatility will keep the markets guessing in
2016 creating more of a sideways market. Historically sideways markets
have proven well for active management creating some favoritism to
actively managed investments. The decline in oil prices is a concern for a
possibility of defaults, and the continued restructuring of China will
continue to cause unease in the markets in 2016.
• Domestic Equity – target return for 2016 mid single digit returns. (4% - 8%)
• Fixed Income – targeted 10-yr 2.75% – 3.00%
• International Equity – mid to high single digit returns (6% - 9%)

2015 LSA Market Outlook
This report and more analysis can be found online.
www.LSABeta.com
Call with any questions: (866)581-5724 or e-mail
support@lsaportfolios.com

Lsa 2016 market outlook

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