ramirez asset management fourth quarter 2016 general market update

 

     

RAMIREZ ASSET  MANAGEMENT  

FOURTH QUARTER 2016   GENERAL MARKET UPDATE

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Ramirez Asset Management EXECUTIVE SUMMARY In a quarter full of surprises, perhaps the least of them was the 25 basis point increase in December by the Fed in its benchmark rate to a target of 50-75 basis points. However, the FOMC still managed to catch investors off guard with its outlook for three additional rate hikes in 2017, up from two that it had forecast at its September meeting. On this schedule, Fed Funds would increase to about 1.4% next year, which is still not particularly high considering that 2017 looks to be the 8th year of the economic expansion. The FOMC forecast also included three rate hikes in 2018. Behind the gradual increase in the Fed Funds rate is a monetary policy that supports “some further strengthening in labor market conditions and a return to 2% inflation”. Core PCE inflation averaged 1.4% in 2015, and as of November 2016 was running at around 1.7%. The FOMC’s GDP predictions were up slightly from its prior meeting to 2.1% in 2017, 2% in 2018 and 1.9% in 2019, and did not include any stimulus from President-elect Donald Trump’s supply–side economic policies. This brings us to arguably the biggest surprise in the quarter if not for the entire year – the election of Donald Trump as the next U.S. President. The only thing that may have topped the election outcome was its apparently unanticipated impact on both the stock and bond markets. While the S&P 500 increased 9.53% and the Dow approached 20,000, the U.S. bond market gave up all of its 2016 gains, and the entire Treasury curve ended the year at levels not seen since mid-2015.

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Incorporated in this immediate impact on the financial markets by the Trump presidency and the Republican sweep in Congress were: 1. 2. 3. 4. 5.

Revisions to the Affordable Care Act (“Obamacare”) Revisions to Dodd-Frank (“dismantling”) The passage of a large infrastructure bill Rewriting the corporate tax code A willingness to ignore the impacts of promised changes to trade policy and immigration reform

In general, the reaction by bond investors to these tenets was rational if perhaps overdone. Revisions to Obamacare and Dodd-Frank would be especially impactful to the health care and financial sectors. With the economy operating close to full capacity, the kind of expansion driven by infrastructure spending could lead to incremental wage increases and thus overall inflation. Rewriting the corporate tax code might also have the effect of increasing investment spending if marginal tax rates were to decline Restrictive trade policies could also lead to higher inflation by making imports more expensive. Treasury yields began the quarter with 2-year Treasuries at .77%, 10-year Treasuries at 1.60% and the 30-year Treasury at 2.32%. After the November 8 elections rates begin moving higher with 2-year, 10year and 30-year Treasuries closing out the year at 1.19%, 2.45%, and 3.07%, respectively. While the year-over-year increase was not terribly dramatic with 10-year rates increasing 18 basis points, the move from June 30, 2016 was considerably more impressive. The 10-year Treasury, for example, increased almost 100 basis points from 1.47% to 2.45% in that timeframe. Outlook:

With higher rates baked into the 2017, RAM maintains a preference for spread product as domestic and international investors will continue to be attracted to these yields on both an absolute and relative basis. Our focus will be on high quality, liquid Corporate, Municipal, and Securitized Product, and positioning on the yield curve that will enable us to benefit from the increase in the overall level of interest rates.

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Ramirez Asset Management FIXED INCOME PERFORMANCE REVIEW

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Aggregate (1 - 30+ Years) Sectors

Sector & Index Performance Total Return Excess Return 4Q 2016 4Q 2016

Total Return Excess Return Trailing 1 Year Trailing 1 Year

U.S. Corporate High Yield Index Hybrid Adjustable Rate Mortgage Backed Securities Asset Backed Securities (ABS)

1.75% -0.58% -0.70%

4.07% -0.29% 0.03%

17.13% 1.81% 2.03%

15.73% 0.27% 0.95%

Covered Bonds U.S. Agencies Fixed-Rate Agency Mortgage Backed Securities U.S. TIPS 1-10 Years

-1.53% -1.96% -1.98% -2.41% -1.47%

0.03% -0.04% -0.39% 0.00% 0.00%

2.05% 1.39% 1.67% 4.68% 4.01%

0.82% 0.39% -0.11% 0.00% 0.00%

10+ Years Investment Grade Corporates Financial Institutions Industrial

-5.78% -2.83% -1.91% -3.12%

0.00% 1.85% 1.64% 1.92%

7.28% 6.11% 4.00% 7.18%

0.00% 4.93% 2.78% 6.03%

Utility Barclays U.S. Aggregate Index Commercial Mortgage Backed Securities (CMBS) BAML Tax-Exempt Municipals Index

-4.19% -2.98% -3.03% -3.50%

2.16% 0.39% 0.46% -0.48%

6.03% 2.65% 3.32% 0.44%

4.83% 1.38% 2.36% -0.59%

Non-Corporates U.S. Treasuries Intermediate U.S. Treasuries Long U.S. Treasuries BAML Taxable Municipals Index

-3.64% -3.84% -2.25% -11.67% -4.90%

0.18% 0.00% 0.00% 0.00% 1.39%

3.43% 1.04% 1.06% 1.33% 4.97%

2.05% 0.00% 0.00% 0.00% 3.42%

Source: Index and Sector total return and excess return vs. U.S. Treasuries performance provided by Bloomberg Barclays and BofA/Merrill Lynch. Past Performance is not indicative of future results.

U.S. Governments At year-end, 10-year U.K. Gilt bonds, German bonds, and Japan bonds yielded approximately 1.23%, 0.20% and 0.04% respectively. Two, 10 and 30 year U.S. Treasury yields rose in 4Q16 ending at 1.19%, 2.45% and 3.07% and returning -0.4%, -6.7% and -13.9%. The increase in interest rates and yield curve steepening was ignited by expectations that the Trump presidency coupled with a Republican Congress could result in expansionary fiscal policies that would lead to higher inflation and budget deficits. Proposed changes to existing trade policies could have negative implications for export driven companies in the U.S. The Fed also made good on a well-anticipated 25 basis point (“bp”) increase in its benchmark rate to a target of 50-75 basis points. For 2016, 2, 10 and 30 year U.S. Treasuries gained 1.3%, 1.4% and 2.6%, respectively composed primarily of income as yields rose. Inflation expectations increased as the 10-year U.S. Treasury Inflation Protected breakeven rose 1.97% at year-end up from 1.57% at the beginning of 2016. Five and 10 year U.S. Agencies offered spreads of approximately 7 and 36 bps, respectively, to U.S. Treasuries at year-end. U.S. Agencies gained 1.39% for 2016 and -1.96% for 4Q16 producing +39 and –4 bps of excess return. 2

Ramirez Asset Management RAM is underweight U.S. Governments preferring Municipals, Securitized Product and Corporate bonds that offer spread protection from anticipated 2017 Fed rate hikes. Outlook:

Underweight. Prefer spread product at attractive spread versus U.S. Government securities.

U.S. Corporates

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For the year 2016, U.S. Corporates, Long Corporates, and Intermediate Corporates produced total returns of 6.11%, 10.97% and 4.04% basis points respectively. Lower quality industrial credits, particularly in the mid-stream energy, and metals and mining sectors, were double-digit performance leaders, as oil recovered from the January lows of mid $30s/bbl. to end 2016 in the low-to-mid $50s/bbl. U.S. Corporate High Yield gained 17.13% in 2016 surpassing the 11.77% gain of the S&P 500 Index. Corporate bond performance was also aided by the low volatility environment as the Chicago Board Options Volatility Index (VIX) ended 2016 at 14 versus 18 where it began the year. Led by the commodity sectors, Industrials returned 7.18% while the Utility and Financial sectors gained 6.03% and 4.00%, respectively. Industrials, Utilities and Financial Institutions produced 603, 483, and 278 basis points of excess return, respectively. Ex-commodity-related sectors, Industrial credit fundamentals such as interest coverage and leverage generally stabilized in 2016. Financials outperformed U.S. Treasuries but underperformed U.S. Corporates as global growth concerns weighed in, thereby lowering expectations for three or four Fed rate hikes in 2016 to just one. If the Fed carries through with three anticipated rate hikes in 2017, financials will benefit from a steeper yield curve and higher profitability, which should result in additional spread tightening. While the Fed’s balance sheet expansion has ended, the ECB, BOE and BOJ will continue to expand theirs in 2017. Accordingly, U.S. Corporates should continue to offer attractive yield pick-ups for global investors, particularly in the long end, in what remains a historically low rate environment. Yields on U.S. Corporates closed the year at 3.37%; Long Corporates and Intermediate Corporates ended the year at 4.54% and 2.85%, respectively. Higher rates will make it more expensive for issuers and as a result U.S. Corporate bond supply should be slightly less in 2017. From a technical standpoint, this will most likely be positive for spreads. In 4Q16 U.S. Corporates, Long Corporates, and Intermediate Corporates generated total returns of 2.83%, -5.02% and -1.84% respectively. Industrial, Utilities and Financials produced returns of -3.12%, -4.19%, and -1.19% with 192, 216, and 164 basis point of excess returns, respectively. U.S. Corporate bonds benefitted from President-elect Trump’s promises to lower U.S. corporate tax rates, provide for cash repatriation without penalty, and create more American job opportunities. At year-end, long Industrials, long Utilities, and long Financial Institutions yielded 4.59%, 4.28% and 4.53% while the total universe of Industrials, Utilities and Financials yielded 3.46%, 3.55% and 3.15%, respectively. Financials, with a duration of 5.75 years, continue to offer attractive relative value on a

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Ramirez Asset Management duration-adjusted basis, versus, Industrials and Utilities, which have durations of 7.81 and 9.54 years, respectively. Higher expected U.S. company earnings, stock performance, and improved pension funding status will increase the likelihood of pension funds shifting investments to U.S. corporate bonds. U.S. companies’ anticipated earnings growth and forecasted slightly lower new supply should lead to improved profit margins, interest coverages and leverage ratios. A litany of risks to a 2017 corporate bond rally include volatile energy prices, trade and tax policies, the impact of a stronger U.S. dollar on U.S. company earnings, a new President and a Republican Congress, Russian relations, geopolitical risks especially with China, and upcoming elections in the key European countries of the Netherlands, France and Germany. Potential deregulation of the banking sector by the incoming administration has also created uncertainty specific to the Finance sector. What we do know is that the finalization of the Total Loss Absorbing Capacity (“TLAC”) rule will result in lower net issuance needs for the GSIBs than originally expected. As a result of these “known unknowns” going into 2017, RAM does not expect corporate bonds to outperform in a linear fashion. The demand for yield should outweigh the risks in the long haul, but we expect more modest 2017 corporate bond returns than in 2016.

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Outlook:

Modest overweight in select higher yielding midstream energy, metals and mining, and automotive industrial sectors and in financials.

Municipals During the 4th quarter of 2016, the Bank of America/Merrill Lynch (“BAML”) Broad U.S. Taxable Municipal Index generated a return of -4.90%. The sector outperformed duration-matched U.S. Governments by +138.6 basis points as reported by BAML. Deconstructing the -4.90% total return, -5.97% was from price appreciation with +1.07% from income return. The Taxable Municipal Index’s option adjusted spread (“OAS”) over duration matched U.S. Treasuries tightened by 9 basis points from a +142 in June, to a spread of +133 basis points at quarter-end. Long term rates, as measured by the 30 year U.S. Treasury, increased to 3.07% by December 30, from a level of 2.32% on September 30. The 10 year U.S. Treasury ended the quarter at 2.45%, up from its previous quarter-end value of 1.60%. The yield-to-worst on the Broad Taxable Index increased by +57 basis points quarter-over-quarter to 3.89%. At the end of the 4th quarter, the Taxable Municipal Index had an average credit quality of Aa3, an effective duration of 9.24 years, an average maturity of 18.42 years, and generated a trailing 12-month total return of 4.97%. The broad market for Tax-exempt Municipals, measured by the BAML U.S. Municipal Securities Index produced a -3.50% total return in the 4th quarter. The return components included a -4.55% price return and +1.04% from income. For the quarter, Tax-exempts underperformed duration-matched U.S. Governments by +47.9 basis points. During the 4th quarter, the AAA Tax-exempt Treasury basis increased significantly following the US Presidential election but recovered slightly in December. For the quarter, short and long tax-exempt municipals outperformed intermediate securities. The 2-year Municipal/Treasury (M/T) ratio moved from a value of 107.3% in September and ended at 101.7% by December, the 5 year M/T started at 88.7% and cheapened to 92.8%, the 10 year M/T started at 94.6%

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Ramirez Asset Management and ended at 94.5%, and the 30 year M/T ratio started the quarter at 99.7% and ended the 4th quarter at 99.1%.

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Despite the sharp reversal in Municipals mutual fund flows following the US Presidential election, Taxable Municipals outperformed US Treasuries for the quarter as credit spreads compressed owing to shortage of supply and continued improvement in the sector’s underlying credit quality. According to Bloomberg, Municipal issuance in the fourth quarter was approximately $103.1 billion; bringing year-to-date total issuance to $428 billion vs. $376.8 billion for 2015. Of the $103.1 billion total new issuance, $7.1 billion was in Taxable Municipals with high concentrations in AL, CA, FL, NY, and PA where credits from these states accounted for 51% of total taxable municipal new issuances. The majority of new issuances have been advance refundings and we expect the net supply/demand imbalance trend to continue and be supportive to the Municipals sector in the near term. For 2017, market volatility in the Municipals sector is likely to pick up as President-Elect Donald Trump considers various tax reform policies that may affect Municipals and interest rates could continue to trend higher as US economic growth picks up and the unemployment rate remains low. Overall, RAM remains optimistic about the performance of the broad Municipals market. Municipals mutual fund outflows may persist in the near term but we do not anticipate the outflows to be as severe as past cycles. We foresee new issuances to dip slightly relative to 2016 but net new issuances to remain negative after considering current refunding activity. We continue to see improvement in the sector’s underlying credit quality supported by favorable employment trends, anticipated increases in government spending, and strong total tax revenues growth in the largest issuance states such as CA, IL, MN, NY, OR, and TX. Finally, we expect strong demand from both domestic and foreign investors amid attractive yields on a relative value basis (i.e., Taxable Municipals. vs. other similar rated fixed income asset classes) and on an absolute basis (i.e., Taxable Municipals vs. high grade global sovereign bonds). The RAM team expects Taxable Municipals to perform well during periods of market volatility. With regards to portfolio positioning, we remain defensive and continue to favor securities with higher coupons and shorter durations. We anticipate total return to derive from current income and less from price performance. RAM continues to be overweight revenue issuers that have less correlation to cyclical factors. Our allocations to the G.O. sector will continue to focus on state and local governments (states, counties, cities and school districts) with attractive economic growth, favorable population trends and better business climates. With respect to the Revenue sectors, we will look for entities with strong fundamentals that include traditional essential service providers that are monopolistic and have independent rate-setting authority such as utilities. In addition, the team favors credits of wellpositioned airports, established toll roads, large private universities (higher education), public schools and healthcare facilities. Outlook:

Short Term - Positive - Relative value opportunities, broad credit improvement and favorable technical factors. Long Term – Positive – Relative value, defensive, low-correlation, high credit quality and favorable structure options.

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Ramirez Asset Management Agency Mortgage Backed Securities (MBS) The U.S. Agency Mortgage Backed (MBS) sector generated a total rate of return for the fourth quarter of -1.97%. For the full year 2016, the sector returned 1.67% which essentially halved the YTD return for the first 9 months of the year. With longer term rates moving higher during the quarter, the 30-year and 20-year mortgage sub sectors had much lower returns for the quarter compared to the 15-year sub sector. Thirty-year and twenty-year mortgages returned -2.16% and -2.33%, respectively while the 15-year sector returned -1.72%. For the full year, the longer tenures managed to eke out modestly better returns than their 15-year counterparts. Thirty-year mortgages returned 1.76% while 20-year mortgages returned 1.82%, both ahead of the 1.50% return for 15-year mortgages.

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The sector as a whole had -39 basis points in excess return, which was primarily generated by 20 and 30year mortgages with excess returns of -74 and -50 basis points, respectively. The rather poor showing by 20-year paper was, we believe, due to the lower sensitivity to prepayments in the embedded options in this sub- sector. Fifteen year mortgages had -5 basis points in excess return for the quarter. For 2016, the excess return for the sector was -11 basis points as the fourth quarter negative excess returns essentially negated the positive YTD advantage the sector had going into the fourth quarter. Full year excess returns were -14, 6, and 10 for 30-year, 20-year, and 15-year mortgages, respectively. To summarize the fourth quarter essentially cut in half absolute returns for the sector and negative excess returns in the quarter basically brought full year relative returns to flat levels. The average life stability that was apparent in 3Q16 dissipated in the fourth quarter due to the rise in interest rates. At the end of the quarter the sector’s average life had increased to 7.1 years up from 5.0 years at mid-2016. This average life extension was the direct result of the 10-year Treasury increasing 85 basis points to 2.45% in the quarter. From a price standpoint 30-year FNMA 2.50%, for example, for January delivery had fallen from $101 on September 30 to $94.5 by the end of the year. The fourth quarter vindicated our underweight in the sector in favor of other securitized products. Excess returns ended the year slightly negative while ABS and CMBS generated positive excess returns. While it now is a more difficult decision to remain underweight the sector from strictly an excess return vantage point, RAM will continue to favor ABS and CMBS going into 2017. Our thesis is that longer term rates will shift higher once more at some point during the year, pressuring the sector as average lives lengthen. We are also of the view that the political future of both U.S. Agencies may come up for discussion and put pressure on the sector. RAM continues to see the possibility of higher volatility in the financial markets as the new administration lays down markers with U.S. trading partners. Lastly, there may be pressure by the Trump administration on the Fed to shrink its balance sheet and begin to cut back its purchases of Agency MBS. The sum total of these outlooks continues to cause RAM to underweight the U.S. Agency Mortgage sector in favor of a combination of ABS and CMBS. We currently favor 30 and 20-year paper over 15-year mortgages in an effort to pick up the additional carry offered by these securities and because of our expectations of continued flattening of the term structure. We favor slightly seasoned mortgages trading at modest premiums and best exemplified by 3.50% and 4.00% coupons. 6

Ramirez Asset Management Outlook:

Negative. While much more attractive on a relative value basis, we continue to favor ABS and CMBS over Agency MBS. The directionality of rates, volatility, and potential debate in Washington on the Agencies keep us cautious on the sector.

Commercial Mortgage Backed Securities (CMBS) The CMBS sector produced a return of -3.03% in 4Q16. This result halved the full year return for the sector which was 3.32% for 2016. Looking at excess returns, the sector was by far one of the best performing within the securitized marketplace at +46 basis points. The post-election risk-on trade aided the relative performance of the sector vis-à-vis mortgage-backed and asset-backed securities.

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For the full year the sector generated a very strong +236 basis points in excess return. The sector absorbed a decent amount of supply from multiple issuers. The deals were non-risk retention and still met strong buy side demand even in light of the new December 24th regulation which mandates the risk retention structure for all new issues. Overall supply for the year was below most consensus forecasts as, we believe, borrowers and underwriters took advantage of other avenues of funding, aiding overall sector performance. Investment managers with yield based targets also supported the sector, especially in the AAA to AA space. Spread tiering continues to evolve, a fact we believe will become more pronounced in 2017 as the differentials between risk retention and non-risk retention deals and overall underlying credit quality metrics will push risk premiums further apart per given unit of risk. Spreads were tighter across the board with BBB tranches outperforming their higher rated AA and AAArated counterparts. The flattening of the yield curve was the primary driver as investors sought out yield with acceptable risk by moving into the sector’s subordinated tranches. Going forward we believe the new risk retention rules should theoretically improve underwriting standards as issuers will “have skin in the game”. Also helping to support the market will be a general forecast for modest supply as issuers go to the single asset-single borrower (SA/SB) or obtain direct funding from non-traditional sources such as insurance companies. Our decision to overweight the CMBS sector comes with modest conviction and with the caveat that RAM may significantly alter the sector outlook over the intermediate term. We like overall spread levels, but expect only modest performance from the contraction in risk premiums with most excess return coming from yield carry. We believe that underwriting standards have stabilized, and that new regulatory rules will build on the improved quality and underwriting experienced in 2016. While we believe that the domestic CRE market remains on substantially sound footing we are concerned about the retail sector, which appears to be under considerable stress. This concern has moved beyond Sears and JC Penny to include any secondary or tertiary retail anchored mall establishment in general. We are also keeping a close eye on the underlying operators/landlords. Retail aside, we believe that the fundamentals of the CMBS market remain quite sound and that risk premiums are still attractive. RAM will also be making selective investments in SA/SB deals to take advantage of opportunities in properties with strong fundamentals, solid underwriting, and attractive spreads.

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Ramirez Asset Management Outlook:

Positive. After a strong 2016 in terms of excess returns, we continue to favor the sector as we see continued strong investor demand, sound underwriting, new regulations, and reasonable commercial real estate valuations supporting the sector over the intermediate term.

Asset Backed Securities (“ABS”)

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The ABS sector produced a total rate of return of -0.70% in the fourth quarter 2016. The full year results produced a total return of 2.03%, a result well ahead of both 30-year and 15-year agency mortgage passthroughs. The sector continued its uninterrupted string of quarterly excess returns though by a thin margin of +3 basis points. The full year excess return- was +95 basis points, an excellent result for such a short duration, high quality sector and far superior to the -11 basis points in Agency mortgages. Credit Card ABS lost -1.04% in the quarter while auto ABS came in at -0.27%. This relative mismatch was duration driven; however there was a noticeable difference in excess returns for the quarter as credit cards had -6 basis points in excess return while autos had +10 basis points. For the full year 2016, credit card ABS returned 1.92% with +78 basis points in excess return. Auto ABS returned 2.16% for the year with +117 basis points in excess return. Considering the relative short duration and overall interest rate environment these are excellent absolute and excess returns. Supply was manageable in the fourth quarter with investors quickly taking dealers out of any paper with 2-year or so average lives. As was the case with CMBS, lower-rated tranches added significant value for the quarter. The AAA only ABS component, which represents 90% of the ABS Index, returned -0.76% and 1.85% for the year, 6 and 18 basis points less than the sector as a whole. We continue to like the prime and sub-prime auto sub-sectors for their relative value propositions and short durations. We think risk premiums can grind tighter over the intermediate term, with levels getting back to the tights of 2013. RAM continues to avoid student loan and credit card ABS for fundamental and valuation reasons, respectively. We believe the lowered underwriting standards of 2015/2016 will start to flow through to the credit metrics of auto ABS in 2017 and much more so in 2018. Both new and used auto sales have probably peaked as the economic cycle continues to age and the marketplace for cars becomes saturated. This may mean used car prices and thus recovery rates will plateau if not outright decline. Helping to support the fundamental credit picture are low unemployment and continued growth of the domestic economy. Additionally, most issues have strong credit support and performance trends which increase as short maturity tranches pay-off and the deal structure de-levers. This typically leads to a one notch upgrade 12 to 24 months from issuance. We will continue to favor subordinated tranches of the larger, veteran issuers and take a more cautious stance on smaller underwriters and on esoteric collateral in general. Outlook:

Positive. While closely monitoring credit metrics, we remain overweight subordinated tranches of better structured and top tier auto ABS sponsors. We expect modest contraction in spreads and also incremental value added from yield carry.

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Ramirez Asset Management Equity As the fourth quarter and year came to a close, it was driven by two stories, the election of Donald Trump and the FOMC. With the Trump election the market had an unprecedented move as if it had gone through a whole market cycle in a matter of hours. The futures market on that day briefly sank but quickly turned around and rallied through the end of the year. The year-end rally was motivated by Investors betting that the new administration will spend heavily on infrastructure, cut taxes, and reduce regulations, creating a business friendly environment. The second story was that interest rates rose with the Fed raising rates by 25 basis points in December, the first increase in a year. The boost was widely expected and the market did not have much of a reaction to it. Still exuberance took hold of the markets and built in expectations for stimulus, higher inflation, and higher interest rates.

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Expectations are extremely high in some sectors with the new administration and its plans. A major beneficiary of the possible new environment with increasing rates and fewer regulations was the financial services sector. This pushed the sector close to fairly valued levels especially in the bulge bracket banks and some regionals. The other sector with high expectations is industrials which is outperforming the broader market. Optimism for potentially stronger U.S. economic growth ahead, largely driven by the prospect of infrastructure spending, has added a premium to the valuations of the sector. While we see the possibility of infrastructure spending a positive for the sector we think it’s a bit early to assume such a premium. We think the rally in the sector has pushed most of the companies into overvalued territory. A story that was widely discussed during the election period and one that will be ongoing for the next year was the concern surrounding drug pricing. We don't see any major shifts in U.S. drug prices over the next several years under the new administration but do see pricing pressure from the powerful Pharmacy Benefit Managers. The PBM’s and possibly changes to the Affordable Healthcare Act may hinder U.S. drug pricing growth which could add pressure to some drug stock valuations. An area that may not be affected by this would be the biotech and specialty drug companies which have more pricing flexibility. They may also be the motivators of M&A activity within the sector as some larger drug companies look for faster growth without spending more on R&D. The consumer discretionary sector has high expectations for 2017 driven by high consumer sentiment and improved expense and inventory management. However, we think several companies could be at risk due to their manufacturing being done in Mexico and Asia. The new administration's policies which may include heavily amended or outright repeals of current trade agreements may increase costs and taxes for their production. The full impact is not likely to be known for some time but adds risk to the majority of the Retail and Automotive sectors. Technology, which has high levels of manufacturing operations in China will be the biggest sector at risk given the incoming administration’s stance on existing trade agreements with China. The energy sector has had an impressive quarter after OPEC's recently announced production cuts which remove more than 1 million barrels per day from an oversupplied system. Though this is a near term positive, as long as OPEC constituents live up to their promises, longer term a recovery in oil prices will encourage U.S. producers to further ramp activity. This would eventually replace almost all the cut oil production from OPEC. With that in mind we view energy sector valuations as overvalued at current levels. The consumer defensive sector has been one of the few sectors to not have really participated in the recent rally and has even pulled back modestly. The sector now trades at a discount to our fair value estimates. Though some of the sector is at risk due to possible changes in trade agreements under the

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Ramirez Asset Management new administration we believe there are some pockets of value within some of the sectors as well as optimism for continued M&A activity in the space. Short and long term cautious. Corporate earnings are slowly improving but some sectors are fairly-to-overvalued after the recent rally. We are cautious on the uncertainty of the policies of the new presidential administration and if and when they will be enacted. We expect some short term volatility in the first 100 days of the Trump presidency as the market adjusts to news of any changes in policy, trade restrictions or taxes. Until there is clarity on what the new administration can do short term we are cautious long term to know their affects.

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Outlook:

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Ramirez Asset Management FIXED INCOME MARKET REVIEW

Date

2 yr

3 yr

5 yr

7 yr 10 yr 20 yr 30 yr

12/31/2015

0.14 0.16 0.49 0.65 1.06

1.31

1.76

2.09

2.27

2.67

3.01

12/31/2016

0.44 0.51 0.62 0.85 1.20

1.47

1.93

2.25

2.45

2.79

3.06

1 Year Change

1 mo 3 mo 6 mo 1 yr

0.30 0.35 0.13 0.20 0.14 0.16 0.17 0.16 0.18 0.12 0.05 Source: US Department of the Treasury (www.Treasury.gov)

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One-Year Change in the U.S. Treasury Yield Curve

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Ramirez Asset Management The Macroeconomic Roadway Political Risk

 Rise of populism in advanced economies and concerns about job losses due to immigration, trade, and technology may dominate welfare gains rising from globalization

Economic Growth (US)

 Despite minor upward revisions, US GDP growth expectations hover around 2% minus versus a historical average of ~3%  Questions remain whether structural reforms (tax, infrastructure, spending, healthcare) proposed by the new administration will push GDP growth back to its historical average

QUARTER FOURTH

 IMF lowers its global growth forecast with Brazil, China and Russia taking the bulk of the blame, while European and Brexit concerns cloud the horizon

Labor Markets (US)

 The unemployment rate remains near its natural rate

(International)

 Employment conditions in the Eurozone bifurcate as countries such as Germany shine, whereas Mediterranean-rim countries exhibit strains

Inflation

 The FOMC still expects that inflation will rise to its long-run level of 2%, once oil and import prices stop falling. US services inflation fluctuates around 3% as goods inflation hovers in negative territory

 Average wages rise by 2.9% YoY, and the Fed’s Labor Market Conditions index rebounds from its lows in the 1H 2016

 While survey-based inflation expectations (U. of Mich.) trend down, market-based measures jump following the election

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(International)

 As the Euro area and Japan move into disinflation, the number of countries experiencing negative rates rises Monetary Policy (Fed)

 The Fed estimates that the equilibrium real rate, r*, is near zero in the short-term and 1% in long-term  As the unemployment and inflation gaps narrow, the Fed increases its fed funds rate projections by three 25 bps hikes in 2017 and to 3% in the long-term

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Ramirez Asset Management (International)

 As the ECB overtakes the Fed as the major provider of global liquidity, international capital flows into the US, lifting the dollar but lowering US bond yields

Fiscal Policy

 Business and household surveys begin to reflect expectations of progrowth fiscal and economic reforms. Hard data will lag these expectations as the passing and end-effects of new legislation will take time

The Markets

 The unexpected outcome of the US election shocks the markets. 10year rates increase by about 60 bps through 2016YE, equally divided between increases in inflation expectations and the real rate. The S&P returns over 5% since the election, and small caps surge  Following a year of declining rates globally, sovereign rates in Europe and Japan return to positive territory in the 10-year maturities

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 Stress indicators fall from highs in early 2016

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Ramirez Asset Management

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U. S. Economy

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Ramirez Asset Management

The Fed Funds Rate

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US Government Rates Outlook

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Ramirez Asset Management

Labor Market Conditions

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Inflation Indicators

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Ramirez Asset Management

Reactions to the U.S. Presidential Election (Continued)

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Reactions to the U.S. Presidential Election

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Ramirez Asset Management

Reactions to the U.S. Presidential Election (Continued)

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Reactions to the U.S. Presidential Election (Continued)

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Ramirez Asset Management

Overseas Economies

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Political Risk Around the World

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Ramirez Asset Management RAMIREZ ASSET MANAGEMENT (“RAM”), founded in 2002, provides asset management services for institutional investors. The firm specializes in fixed income and offers customized investment programs for each of our clients. Our firm consists of experienced professionals whose singular mission is to provide our clients with the highest quality of fixed income management and service. RAM utilizes a full range of resources and infrastructure to work with our clients to analyze, develop, and implement a fixed income strategy to meet their goals and objectives.

 Core

 Strategic Core

 Intermediate

 Strategic Intermediate

 Intermediate Core

 Long Duration

 Short Duration

 Enhanced Cash / Cash

 Bond Proceeds Management

 Liability Driven Investing

For more information, please contact: Samuel A. Ramirez, Jr. President and CEO Phone: (212) 248-0531 Fax:

(212) 378-7140

E-mail: [email protected]

Disclaimer: The views expressed are the views of Ramirez Asset Management through the period ending December 31, 2016 and are subject to change at any time based on market and other conditions. Sources of index performance and related data include Barclays, Bank of America/Merrill Lynch, and Bloomberg. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.

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Investment strategies that we offer:

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