H E A L T H W E A L T H C A R E E R
M E R C E R W E B C A S T
M A R K E T E N V I R O N M E N T
July 21, 2016
Anthony BrownUS Director of Strategic Research
Lucy TusaPrincipal
© MERCER 2016 1
L I Q U I D I T Y S W A M P E D T H E I M P A C T O F B R E X I T
Past performance is no guarantee of future results. Please see Important Notices for further information.
-2.6-1.5
0.10.60.7
1.11.7
2.12.5
2.73.23.4
3.63.73.8
5.512.512.8
-5 0 5 10 15
Intl Sm-Cap StksIntl Large-Cap Stks
T-BillsFunds of Hedge Funds
Emerg Mkt StksUS MBSUS TIPS
US TreasuriesUS Large-Cap Stks
Emerg Mkt Debt (Local)US Mid-Cap Stks
Global FixedUS I/G Corp Bonds
Global REITsUS Small-Cap Stks
US High Yield BondsNatural Res Stks
Commodity Futures
Second Quarter Performance (%)
Source: Datastream
© MERCER 2016 2
B R E X I T : T H E P O L I T I C S
• The result of the EU Referendum held on June 23, 2016was a 52% / 48% victory for the “Leave” campaign
• David Cameron resigned and Theresa May has replacedhim as Prime Minister
• Given the strong support for “Remain” in Scotland, NicolaSturgeon has held talks with EU leaders and may seek asecond referendum on Scottish independence
• Similarly, senior politicians in Northern Ireland havesuggested that they may also seek some special statuswithin the EU and there have been calls for a vote onIrish re-unification.
• Jeremy Corbyn lost a vote of no confidence by 172 to 40and a leadership election is underway
• The UK now faces several years of politicaluncertainty Source: The Guardian.
Graphic shows geographic support for Remain /Leave weighted by voter populations
© MERCER 2016 3
G I L T S A N D S T E R L I N G
• UK gilt yields at all time lows:– 10 year gilts yield 1% lower than at the start of
2016– 30 year nominal gilts yielded 1.7% as of July
1st.
• Mark Carney has suggested that the BoE is likelyto ease policy over the summer– This could include rate cuts and quantitative
easing– Markets are now expecting no rate hikes until
after 2020– The March 2018 gilt dipped below a zero yield
(the first negative-yielding nominal UK gilt)
• The pound sterling has reached its lowest levelagainst the US dollar since 1985
• S&P downgraded the UK from AAA to AA– Fitch downgraded the UK from AA+ to AA and
Moody’s placed the UK on a “negative watch”
© MERCER 2016 4
K N O W N U N K N O W N S
• Short-term impact on UKeconomy expected to benegative
• Medium to longer-termeffects much harder topredict.
• General election / anotherreferendum?
• UK ‘s negotiating stance?
• Scottish referendum?
• Irish referendum?
• EU negotiating stance?
• Calls for referenda in othercountries?
• Elections in Germany,France and Netherlands in2017 and a constitutionalreferendum in Italy(October 2016)
• Markets remain fragile dueto heightened uncertaintyand reduced liquidity
• Policy-maker response willalso be important (i.e.monetary and fiscal policy)
DOMESTICPOLITICS
EUROPEANPOLITICS
ECONOMICEFFECTS
MARKETEFFECTS
Brexit is not taking place within a vacuum – it is just one part of a complex macro-economicpicture containing many sources of uncertainty (e.g. China and the US)
© MERCER 2016 5
P O S S I B L E B R E X I T M O D E L S
Tariff free tradewith EU
Negotiates owntrading terms withcountries outside
the EU?
Freemovementof persons
Contributionto EU budget
Eurozonemembership
Require domesticlegislation
equivalent to EU lawVotes on EU
law?
The NorwayModel (EEA
Model)Yes Yes Yes Yes No Yes, except on fishing
or farm policies No
The SwissModel
Partially – mostgoods, but notmost services
Yes Yes Yes No Yes No
The TurkishModel
Partially – somegoods, notservices
Yes, but tariffsmust be aligned
with EU.No No No
Yes in certain areassuch as consumer
protection,competition and
intellectual property
No
The CanadianModel
Partially – somegoods, notservices
Yes No No No No No
The WorldTrade
OrganizationModel
Exports wouldface EU’s
WTO tariff ratesand will continueto have to meet
EU productstandards
Yes No No No No No
Source: Based on information in the HM Government “Alternatives to membership” paper (March 2016).
© MERCER 2016 6
R I S K O F C O N T A G I O N
• Brexit is at least in part the result of secularglobal forces – economic inequality and loss oftrust in “mainstream” politicians- that have takenhold in the aftermath of the financial crisis
• Symptoms of this broader malaise include therise of far-right and far-left parties acrossEurope (e.g. Syriza in Greece, Freedom Partyin Austria, National Front in France); the rise ofTrump in the US; the rise of UKIP and theelection of Corbyn as Labour leader in the UK
• Public support for a referendum is above 50% inboth France and Italy– Both countries have also seen rising support
for populist / extremist political parties
• The exit of a major Eurozone member would bean order of magnitude more destabilising thanBrexit
Source: HSBC
© MERCER 2016 7
B R E X I T S H O U L D H A V E L I M I T E D I M P A C T O N G L O B A LG R O W T H , B U T C O N T A G I O N R I S K S R E M A I N
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Oct
'14
Dec
'14
Feb
'15
Apr'
15
Jun
'15
Aug
'15
Oct
'15
Dec
'15
Feb
'16
Apr'
16
Jun
'16
Apr'
15
Jun
'15
Aug
'15
Oct
'15
Dec
'15
Feb
'16
Apr'
16
Jun
'16
Perc
enta
gech
ange
Month of Forecast
Consensus GDP Growth Forecasts
United States
Source: Bloomberg
Eurozone
United Kingdom
2016 Forecast 2017 Forecast
Japan
© MERCER 2016 8
E M G R O W T H S T A B I L I Z I N G
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
Mar
-14
Jun-
14
Sep-
14
Dec
-14
Mar
-15
Jun-
15
Sep-
15
Dec
-15
Mar
-16
Jun-
16
(%)
2016 GDP GrowthConsensus Expectations
China India
Brazil Russia
Source: Bloomberg
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
Mar
-15
May
-15
Jul-1
5
Sep-
15
Nov
-15
Jan-
16
Mar
-16
May
-16
Jul-1
6
(%)
2017 GDP GrowthConsensus Expectations
China India
Brazil Russia
Source: Bloomberg
© MERCER 2016 9
U S I N T E R E S T R A T E S R E A C H E D N E W L O W S
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
Jan-
08Ju
l-08
Jan-
09Ju
l-09
Jan-
10Ju
l-10
Jan-
11Ju
l-11
Jan-
12Ju
l-12
Jan-
13Ju
l-13
Jan-
14Ju
l-14
Jan-
15Ju
l-15
Jan-
16
US 10-year Treasury Yield
Source: Bloomberg
0.0
0.5
1.0
1.5
2.0
2.5
Jan-
15Fe
b-15
Mar
-15
Apr-1
5M
ay-1
5Ju
n-15
Jul-1
5Au
g-15
Sep-
15O
ct-1
5N
ov-1
5D
ec-1
5Ja
n-16
Feb-
16M
ar-1
6Ap
r-16
May
-16
Jun-
16Ju
l-16
(%)
Fed Funds Futures
Dec-16
Dec-17
Source: Bloomberg
© MERCER 2016 10
W H A T ’ S T H E M E S S A G E F R O M T H E B O N DM A R K E T ?
0
2
4
6
8
10
12
14
16
18
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
2016
(%)
10-Year Treasuryand Nominal GDP Growth
10-Year Treasury YieldRolling 10-year Nominal GDP Growth
Source: Bloomberg
-1
0
1
2
3
4
5
1957
1961
1965
1969
1973
1977
1981
1985
1989
1993
1997
2001
2005
2009
2013
(%)
Productivity Growth(Non-farm Business Output Per Hour)
Rolling 3 yrs
Rolling 10 years
Source: Bloomberg
© MERCER 2016 11
G L O B A L C O N D I T I O N S S I G N I F I C A N T L YI N F L U E N C I N G U S R A T E S
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Jan-
14
Apr-1
4
Jul-1
4
Oct
-14
Jan-
15
Apr-1
5
Jul-1
5
Oct
-15
Jan-
16
Apr-1
6
10-Year Yields on Select GovernmentBonds
Germany Swiss
UK US
Source: Bloomberg
60
65
70
75
80
85
90
95
100
Jan-
11M
ay-1
1Se
p-11
Jan-
12M
ay-1
2Se
p-12
Jan-
13M
ay-1
3Se
p-13
Jan-
14M
ay-1
4Se
p-14
Jan-
15M
ay-1
5Se
p-15
Jan-
16M
ay-1
6
Trade-Weighted DollarMajor Currencies
TW Dollar (Major)
200d m.a.
Source: Bloomberg
© MERCER 2016 12
U S L A B O R M A R K E T C O N D I T I O N S T I G H T E N I N G
0
1
2
3
4
5
6
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
(%)
Wage Growth(Rolling 12 Months)
Average Hourly Earnings
Atlanta Fed Wage Tracker
Source: Bloomberg, Federal Reserve
0
3
6
9
12
15
18
0
2
4
6
8
10
12
1948
1952
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
2016
(%)
(%)
Unemployment Rates
Headline
U-6
Source: Bloomberg
© MERCER 2016 13
C O R E I N F L A T I O N M E A S U R E S T R E N D I N GH I G H E R , W H I L E E X P E C T A T I O N S D E C L I N I N G
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
(%)
InflationRolling 12-months
Core CPI Core PCE DeflatorSource: Bloomberg
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Mar
-09
Sep-
09M
ar-1
0Se
p-10
Mar
-11
Sep-
11M
ar-1
2Se
p-12
Mar
-13
Sep-
13M
ar-1
4Se
p-14
Mar
-15
Sep-
15M
ar-1
6
(%)
Inflation Breakeven Rate on TIPS
5-year
5-yr / 5 yrs Forward
Source: Bloomberg, Mercer
© MERCER 2016 14
L O W E X P E C T E D R E T U R N S F R O M F I N A N C I A LA S S E T S
-2
0
2
4
6
8
10
12
14
1619
50
1954
1958
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
2002
2006
2010
2014
(%)
Real Expected Returns on Stocks and BondsExpected Real Yield on 10-yr TreasuriesNormalized Earnings Yield on S&P 50060/40 Blend Expected Real Return
Source: S&P, Federal Reserve, Bloomberg, Mercer
© MERCER 2016 15
C R E D I T L E S S AT T R A C T I V E
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
(%)
Investment-Grade Corporate BondCredit Spread
OAS
Median OAS
Quality Adjusted Median OAS
Source: Barclays, Mercer
2
4
6
8
10
12
14
16
18
20
22
Jan-
14M
ar-1
4M
ay-1
4Ju
l-14
Sep-
14N
ov-1
4Ja
n-15
Mar
-15
May
-15
Jul-1
5Se
p-15
Nov
-15
Jan-
16M
ar-1
6M
ay-1
6
(%)
High Yield BondOption Adjusted Credit Spread
HY Energy
HY ex. Energy
Source: Barclays
© MERCER 2016 16
L O W I N T E R E S T R A T E S S U P P O R T I N G E Q U I T YV A L U A T I O N S
2.0 2.1 2.1 1.8-0.8
1.92.9
4.8
9.6 7.5
2.3 1.1
-2
0
2
4
6
8
10
12
14
3 Yrs 5 Yrs 10 Yrs 20 Yrs
(%)
MSCI US Equity IndexReturn Decomposition
(As of 6/30/16)Interaction effectP/E expansionEarnings growthDividends
Source: Datastream
0
10
20
30
40
50
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
2016
US Equity Valuations
Trailing 12m P/E
Shiller P/E
Source: S&P, MSCI, Datastream, Mercer
© MERCER 2016 17
R I S I N G W A G E S A N D W E A K P R O D U C T I V I T YG R O W T H P R E S S U R I N G P R O F I T M A R G I N S
-3
-2
-1
0
1
2
3
4
5
6
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
(%)
Productivity and Hourly Wage GrowthRolling 4 Quarters
Real Compensation Per Hour
Non Farm Business Output
Source: Bloomberg
0%
2%
4%
6%
8%
10%
12%
14%
16%
52%
54%
56%
58%
60%
62%
64%
66%
68%
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
Afte
r-Ta
xPr
ofits
Com
pens
atio
nof
Empl
oyee
s
Employee Compensation and ProfitsShare of Non-financial Corporate GDP
Employee Compensation (LS)Corporate Profits (RS)
Source: Bureau of Economic Analysis
© MERCER 2016 18
I N T E R N A T I O N A L V A L U A T I O N S R E L A T I V E L YA T T R A C T I V E , B U T U N C E R T A I N E A R N I N G S O U T L O O K
22.0
20.0
13.813.8
23.2
14.2
17.6
10.8
13.2
9.6
7.0 8.2
2.8 1.7 1.1 1.52.1
3.7
2.4 2.8
0
5
10
15
20
25
30
MSCI US MSCI Europe MSCI Japan MSCI EM
Global Valuations
P/E Trailing Shiller's P/E
P/CF P/B
Dividend Yield
Source: Bloomberg, Datastream, Mercer
-5
0
5
10
15
20
25
1990
1993
1996
1999
2002
2005
2008
2011
2014
(%)
Return-On-Equity for Global Markets
MSCI Europe MSCI Japan MSCI US
Source: Bloomberg, Datastream, MSCI
© MERCER 2016 19
C O N C L U S I O N S
• Base case of low, stable economic growth most likely, but the downside risks are increasing– Contagion risk from Brexit– Growing popularity of populism– Chinese growth
• The Fed could surprise the bond market
• Recovery in credit reduced relative attractiveness
• Equities offer an attractive return relative to bonds in the base case, but little margin for error
• Continue to seek alpha and other alternative sources of return
© MERCER 2016 20
Q U E S T I O N S ?
QUESTIONSPlease type your questions in the Q&A section of the toolbarand we will do our best to answer as many questions as wehave time for.
To submit a question while in full screen mode, use the Q&Abutton, on the floating panel, on the top of your screen.
CLICK HERE TO ASK A QUESTIONTO “ALL PANELISTS”
FEEDBACKPlease take the time to fill out thefeedback form at the end of this webcastso we can continue to improve. Thefeedback form will pop-up in a newwindow when the session ends.
Anthony Brown Lucy TusaSt. Louis London+1 314 982 5741 +44 (0)20 7178 [email protected] [email protected]
© MERCER 2016 21
Important NoticesReferences to Mercer shall be construed to include Mercer LLC and/or its associated companies.
© 2016 Mercer LLC. All rights reserved.
Information contained herein has been obtained from a range of third party sources. While the information is believed to be reliable, Mercer has not sought to verify it independently. As such,Mercer makes no representations or warranties as to the accuracy of the information presented and takes no responsibility or liability (including for indirect, consequential or incidental damages)for any error, omission or inaccuracy in the data supplied by any third party.
No investment decision should be made based on this information without first obtaining appropriate professional legal, tax and accounting advice and considering your circumstances.
Investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.
Mercer Investment Management, Inc. and Mercer Investment Consulting LLC are federally registered investment advisers under the Investment Advisers Act of 1940, as amended. Registrationas an investment adviser does not imply a certain level of skill or training. Mercer’s Form ADV Part 2A & 2B can be obtained by written request directed to: Compliance Department, MercerInvestments, 701 Market Street, Suite 1100, St. Louis, MO 63101.
MMC Securities LLC is a registered broker dealer and an SEC registered investment adviser. Securities offered through MMC Securities; member FINRA/SIPC, main office: 1166 Avenue of theAmericas, New York, New York 10036. Variable insurance products distributed through Marsh Insurance & Investments LLC; and Marsh Insurance Agency & Investments in New York. Mercer,Mercer Investment Consulting, LLC, Mercer Investment Management, Inc., Guy Carpenter, Oliver Wyman, Marsh and Marsh & McLennan Companies are affiliates of MMC Securities.
Download a guide on key index definitions.