Morningstar Markets Observer
®
Q2 2017 Data as of March 31, 2017
Morningstar ® Research
Timothy Strauts
Bob Johnson, CFA
Director of Quantitative Research
Director of Economic Analysis
Alina Lamy
Barbara Kennedy
Senior Analyst
Associate Graphic Designer
Zurab Margvelashvili
James Li
Quantitative Analyst
Quantitative Analyst
Morningstar Markets Observer
®
Q2 2017 Data as of March 31, 2017
Table of Contents
Market Overview
3
Equities
14
Fixed Income
23
Funds
30
Economic Indicators
37
Market Overview
Market Dashboard
All equity and fixed-income indexes had strong returns in the first quarter. Emerging markets were the best performers in both equity and fixed income as their currencies
strengthened against the dollar and investors perceived less risk of harmful U.S. trade policies. Commodities, on the other hand, were dragged into negative territory by
falling oil prices. The strong small-cap rally after the election has slowed in 2017 as small-cap stocks fell behind large-caps so far this year.
Fundamental Measures
Return (%)
12 Month Yield
YTD
3 Mo
1 Yr
3 Yrs
5 Yrs
10 Yrs
P/E
P/B
P/S
P/C
2.3
1.4
2.8
2.3
6.1
2.5
7.2
11.4
6.1
2.5
7.2
11.4
17.2
26.2
11.7
17.2
10.4
7.2
0.5
1.2
13.3
12.4
5.8
0.8
7.5
7.1
1.1
2.7
21.2
22.0
18.2
14.5
3.0
2.2
1.6
1.6
2.1
1.3
1.2
1.4
13.1
10.9
8.6
7.8
S&P 500
Russell 2000
MSCI EAFE
MSCI Emerging Markets
Current Yield
U.S. Aggregate
U.S. Corporates
High Yield
Municipals
Emerging Markets (US$)
2.6
3.4
6.2
2.5
5.5
0.8
1.4
2.7
1.6
3.9
0.8
1.4
2.7
1.6
3.9
0.4
2.9
16.9
0.2
8.9
2.7
4.1
4.6
3.5
6.2
2.3
4.3
6.9
3.2
5.8
4.3
5.8
7.3
4.3
7.0
–2.3
–4.4
–2.3
–4.4
8.7
8.5
–13.9
–17.3
–9.5
–10.5
–6.2
–3.3
Broad Commodities
1 Yr Ago
2 Yr Treasury
5 Yr Treasury
10 Yr Treasury
20 Yr Treasury
Prime Rate
1.3
1.9
2.4
3.0
4.0
0.7
1.2
1.8
2.6
3.5
53
1,245
40
1,237
1-Year Return (%)
Value
9.2
Mid
3.3
6.3
7.5
1.5
2.3
5.8
4 to 8
0 to 4
–4 to 0
–8 to –4
–8
Growth
Value
20
Large
7.5
Blend
17.8
21.7
12.6
Mid
Large
2.5
Small
8
5-Year Return (%)
22.8
17.1
15.2
Small
Growth
Brent Crude Oil
Gold
24.3
22.1
20.7
10 to 20
0 to 10
–10 to 0
–20 to –10
–20
Blend
Growth
20
Large
3-Month Return (%)
Blend
Current
Commodities
Bloomberg Commodity
Morningstar Commodity
Value
Interest Rates
12.0
14.7
12.7
Mid
Fixed Income
16.0
13.5
10.9
Small
Equities
13.4
12.7
11.3
10 to 20
0 to 10
–10 to 0
–20 to –10
–20
QMO5
Source: Morningstar Direct. U.S. Aggregate—Barclays U.S. Aggregate Bond Total Return, U.S. Corporates—Barclays U.S. Corporate 5-10 Year Total Return, High Yield—Bank of America Merrill Lynch U.S. High Yield
Master II Total Return, Municipals—Barclays Municipal Total Return, Fixed-Income Emerging Markets—J.P. Morgan EMBI Global Diversified Total Return, Gold—London Fix Gold PM Price Return. ©2017 Morningstar.
All Rights Reserved.
4
Global Market Barometer
One-year returns were impressive all over the world, with Israel being the only exception. In North America, both the U.S. and Canada delivered double-digit returns,
while Mexico lagged on the heels of trade policy rhetoric from the U.S. administration and concerns over NAFTA's future. In Europe, there are also concerns about the
future of the European Union as Britain is scheduled to hold a Brexit summit and French elections unfold in the course of the next two months.
1-Year Trailing Returns of Morningstar Country Indexes in Base Currency by Percentage
20.0
Norway 19.9
Russia 10.9
Sweden 19.8
10.0 to 19.9
0.1 to 9.9
–0.1 to –9.9
–10.0 to –19.9
U.K. 22.0
Canada 18.5
–20.0
Germany 21.0
France 19.5
Spain 24.7
Mexico 6.2
China 27.5
Greece 10.5
Portugal 6.3
United States 17.8
Regions
Italy 13.8
Japan 13.7
Israel –13.7
%
Greater Asia
5.5
Greater Europe 6.5
United States 6.6
S. Korea 14.1
Egypt 85.9
Thailand 15.2
Colombia 4.7
Peru 26.0
India 22.3
Brazil 29.6
Chile 20.4
South Africa 2.5
Australia 21.1
New Zealand 6.5
QMO7
Source: Morningstar Country and Region Indexes. ©2017 Morningstar. All Rights Reserved.
5
Bear Markets Are Painful, but Over the Long Term Markets Rise
There have been eight market downturns since 1926, the most severe one being the Great Depression. More recently, during the “lost decade,” two consecutive downturns with little to no expansion discouraged U.S. investors. However, the market has returned 86.7% since the expansion started in March 2012, and, as the chart
illustrates, there is ample potential for future growth.
U.S. Market Downturns, Recoveries, and Expansions
$10
146
697.7
18.6
An expansion measures subsequent
market performance from the end of
the recovery until it reaches the next
peak level before another 20% decline.
135
523.2
17.7
134
434.5
16.2
A downturn is defined by a decline
in the stock market from its peak by
20% or more.
5
44
193.3
34.1
16
50.9
36.2
1
6
–21.8
21
24.0
13.1
10
35
6
–22.3
9
19
–29.3
151
Growth of $1
60
86.7
13.3
67
85.9
11.7
Recession
12
14.6
14.6
21
21
–42.6
18
25
–44.7
Months
Total Return (%)
Annualized (%)
Months
Total Return (%)
49
3
–29.6
A recovery is represented as the number of months from the bottom
of a contraction to when the market
reaches the level of its previous
peak again.
37
Months
16
–50.9
34
–83.4
0.1
1926
1936
1946
1956
1966
1976
1986
1996
2006
16
QMO6
Source: Stocks—Ibbotson Associates SBBI U.S. Large Stock Index. ©2017 Morningstar. All Rights Reserved.
6
Trailing 12-Month Performance of Major Asset Classes
The last 12 months were strong for all asset classes except bonds, which were hurt by rising interest rates toward the end of 2016. All stock indexes were in double-digit-return territory, boosted by increased investor confidence following the U.S. presidential election in November. Commodities ended the period with good returns, but
they were subject to significant volatility, with the highest returns earned in the second quarter of 2016.
Emerging-Mkts Stocks
20% Rtn
17.8
U.S. Stocks
17.8
Developed-Mkts
Stocks ex-U.S.
11.7
Commodities
10
8.5
U.S. Bonds
0.4
0
–10
Apr
2016
Jul
Oct
Jan
2017
QMO1
Source: U.S. stocks—Morningstar U.S. Market Index. Developed-markets stocks ex-U.S.—Morningstar Developed Markets ex-U.S. Index. Emerging-markets stocks—Morningstar Emerging Markets Index. U.S.
bonds—Morningstar Core Bond Index. Commodities—Morningstar Long-Only Commodity Index. ©2017 Morningstar. All Rights Reserved.
7
U.S. Sector Performance
Technology was the leading sector in the first quarter as tech giants Apple and Facebook returned over 20%. Energy plummeted due to falling oil prices. Over a trailingone-year period, financial services beat out all other sectors, thanks to rising rates and the new administration in Washington. Rising rates help bank margins, and the
potential for lower regulation and tax cuts will boost profitability, but in the last quarter there is more skepticism on whether these measures will happen.
Trailing Quarter
Trailing 1 Year
U.S. Market
17.8
5.9
Cyclical
r Basic Materials
7.4
t Consumer Cyclical
22.8
8.1
y Financial Services
13.3
2.7
u Real Estate
32.0
4.7
1.9
Sensitive
i Communications Services
15.4
2.7
o Energy
–6.5
15.4
p Industrials
4.7
18.7
a Technology
12.5
26.2
Defensive
s Consumer Defensive
5.5
6.8
d Healthcare
8.6
f Utilities
–10%
Return
–5
0
5
6.2
7.7
10
11.5
15
20
25
30
35
QMO4
Source: Morningstar Sector Indexes. ©2017 Morningstar. All Rights Reserved.
8
International Stock Market Performance
After negative performance for almost all regions in the fourth quarter of 2016, international markets all shot upward in the first quarter of 2017. Latin America was
propelled by Brazil's continued recovery from a brutal recession and Mexico's strengthening currency and increased business confidence. Eastern Europe was the best
performer last quarter because markets anticipated better Russian-American relations, but that hope has dwindled since then.
25% Rtn
Trailing Quarter
23.1
Trailing 1 Year
20
18.2
17.8
16.7
14.9
14.7
15
13.3
12.2
11.7
10
11.6
11.0
10.7
10.0
8.4
6.8
6.1
5.3
4.8
5
4.2
2.9
0
Europe
ex-U.K.
U.K.
Asia
ex-Japan
Developed Markets
Japan
Developed
International
Middle East
& Africa
EM Asia
Latin
America
Eastern
Europe
Emerging
Markets
Emerging Markets
QMO3
Source: Morningstar Indexes. ©2017 Morningstar. All Rights Reserved.
9
Good Year for Commodities Overall, but Gold Drops in the Fourth Quarter
Gold prices were up in the first quarter because the dollar stopped rising. An increase in U.S. production triggered a sell-off in energy markets. Industrial metals' strong
performance during the last year was powered by increased manufacturing demand, the new U.S. administration's promises to increase infrastructure spending, and
China's reduced output after reaching dangerous pollution levels.
40% Rtn
Commodity
Industrial Metals
Energy
30
Precious Metals
Livestock
Grains
Trailing
Quarter
Trailing
Year
7.6
–11.4
9.8
0.1
–1.4
26.2
13.6
4.3
–6.6
–7.3
20
10
0
–10
–20
–30
Apr
2016
Jul
Oct
Jan
2017
QC3
Source: Morningstar Direct. Data represented by Bloomberg Commodity Indexes. ©2017 Morningstar. All Rights Reserved.
10
Asset-Class Winners and Losers
Lowest Return (%)
Highest Return (%)
In 2016, returns for all asset classes were positive, and the trend continued in the first quarter of 2017, with one exception: commodities. Emerging markets surged back
after negative performance between 2013 and 2015. Fixed-income categories didn't have a great start to the year as the U.S. raised interest rates and is expected to
continue doing so.
34.0
53.3
25.9
35.0
36.1
39.4
14.1
83.8
28.4
9.4
19.7
37.9
13.6
1.8
20.3
11.7
11.2
13.5
47.7
21.6
25.5
26.6
31.8
–3.2
58.2
23.6
5.2
17.5
31.8
6.9
1.7
17.1
6.9
9.3
11.1
42.4
20.4
15.9
17.0
12.7
–22.2
37.7
21.8
5.0
16.5
22.0
4.9
1.3
12.9
6.3
8.4
–1.4
29.0
17.6
7.0
15.9
10.3
–26.2
36.1
15.1
2.6
16.0
14.3
4.5
–1.4
11.3
4.2
7.0
–3.7
27.0
11.5
5.8
13.0
8.6
–33.8
24.8
13.4
0.6
15.8
7.4
3.9
–1.8
11.2
3.1
6.7
–6.7
24.7
11.1
4.9
11.8
6.7
–36.1
21.8
12.3
–2.6
12.0
0.6
2.5
–4.5
8.6
2.7
6.7
–13.8
22.5
9.5
2.7
4.9
6.0
–36.2
20.9
11.4
–5.3
11.2
–1.8
–0.8
–4.9
4.6
1.4
5.7
–20.4
7.9
4.9
1.1
3.6
1.9
–43.0
19.5
8.5
–11.9
3.7
–2.7
–3.9
–13.3
3.4
0.7
4.5
–23.5
2.7
3.0
0.7
–0.2
–0.7
–53.8
–1.4
7.1
–18.6
2.5
–3.7
–24.4
–26.3
1.2
–4.4
4.0
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
YTD
2002–17
Small stocks
Large stocks
International-developed stocks
Emerging-markets stocks
Inter-term government bonds
Inter-term corporate bonds
High-yield bonds
Commodities
Moderate portfolio
QAA1
Source: Small stocks—Morningstar Small Cap Index. Large stocks—Morningstar Large Cap Index. Int’l stocks—Morningstar Developed Mkts ex-U.S. Index. Emerging stocks—Morningstar Emerging Mkts Index. Interm. govt bonds—Morningstar Interm. U.S. Govt Bond Index. Interm. corp. bonds—Morningstar Interm. Corp. Bond Index. High-yield bonds—Barclays U.S. High Yield Corp. Bond Index. Commodities—Morningstar
Long-Only Commodity Index. Moderate portfolio—Morningstar Moderate Target Risk Index. ©2017 Morningstar.
11
Performance of Risk-Based Portfolios
As expected, an aggressive portfolio with a larger allocation to stocks was able to deliver returns superior to its moderate and conservative counterparts over longer
time periods. However, it also assumes a greater risk level and is therefore more likely to suffer more-severe losses in down markets. The conservative portfolio has been
suffering over the last two years, missing out on the long-term equity bull market.
250% Rtn
Aggressive Total Return (%)
219
Qtr 1 Yr 3 Yr 5 Yr 10 Yr
Risk
6.2 16.7 5.9 9.4
14.5
5
201
200
5.7
95
150
145
Moderate Total Return (%)
Qtr 1 Yr 3 Yr 5 Yr 10 Yr
4.2 10.7 4.5 6.7
100
5.5
Risk
9.0
39
61
50
Conservative Total Return (%)
Qtr 1 Yr 3 Yr 5 Yr 10 Yr
2.0 3.8 2.4 3.1
4.2
Risk
3.8
20
0
80
–50
1999
2002
2005
2008
2011
2014
17
Stocks
Bonds
QAA2
Source: Conservative portfolio—Morningstar Conservative Target Risk Index. Moderate portfolio—Morningstar Moderate Target Risk Index. Aggressive portfolio—Morningstar Aggressive Target Risk Index. Returns
for periods longer than one year are annualized. ©2017 Morningstar. All Rights Reserved.
12
Current Valuations Continue to Limit Asset-Class Return Potential
Our research indicates international-developed and emerging-markets equities will outperform U.S. equities over the next 10 years. We believe that a normalization of discount rates from currently depressed levels will significantly diminish return potential among U.S. equities and less so among non-U.S. stocks. Low starting yields depress
prospective returns of fixed-income securities.
10-Year Valuation-Implied Returns
10-Year Expected Returns
(Nominal Geometric USD)
8.0%
7.61
QoQ Change
6.0
These valuation-implied returns
are based on Morningstar Investment
Management LLC’s forecasts of
corporate and economic fundamentals.
5.72
Our equity model forecasts the sources
of stock returns (inflation, total yield,
growth, and change in valuation) and
is outlined in Straehl and Ibbotson
(2015). Our fixed income model is based
on forecasts of inflation, real rates,
and term and credit spreads.
4.0
3.11
2.74
2.62
2.0
1.45
0.15
0
–0.35
–0.39
–0.05
–0.23
–1.39
–2.0
U.S. Stocks
Intl Developed Stocks
Emerging-Mkts Stocks
U.S. Aggregate Bonds
U.S. High Yield Bonds
Cash
QMO8
Ibbotson, R., & Straehl, P. 2015. “The Supply of Stock Returns: Adding Back Buybacks.” (http://corporate1.morningstar.com/ResearchArticle.aspx?documentId=737061) ©2017 Morningstar Investment Management
LLC. All Rights Reserved. Morningstar Investment Management LLC is a registered investment advisor and subsidiary of Morningstar, Inc.
13
Equities
Morningstar Global Risk Model Factors: Annual Returns
On an annual basis, momentum ranks first eight out of 14 years, more than any of the other four risk factors. Momentum crashes (see 2009, 2016) severely impact its
long-term performance. Diversification into the value factor can help alleviate these drawdowns. Financial health exposure, which overlaps with quality style indices,
most often ranks in the middle of the pack.
Morningstar Global Risk Model Factors: Annual Returns (%)
Size: Premium earned by
small-cap stocks
11.1
7.0
8.3
4.1
11.1
9.6
6.9
7.6
8.9
5.1
8.3
8.0
11.5
9.4
2.4
5.6
Momentum: Premium earned by
stocks with high trailing returns
Value Growth: Premium earned
by stocks with high value score
in value-growth spectrum
7.5
3.6
2.1
4.1
2.5
6.7
6.7
7.3
4.3
2.9
7.6
2.8
7.2
3.3
1.5
4.8
Financial Health: Premium
earned by stocks with strong
financial health score
1.2
2.9
1.9
2.5
1.4
5.4
1.5
1.4
3.8
1.4
2.0
1.9
2.7
1.7
1.3
2.4
Fair Value: Premium earned by
stocks with high quantitative
fair value-to-price ratio
The Morningstar Global Risk Model
assesses equity risk along 36 risk factors
for more than 40,000 stocks and 10,000
equity funds globally.
–3.6
–0.8
0.6
1.4
0.6
5.3
–1.8
1.2
2.5
–0.8
1.5
1.9
2.1
–1.4
0.5
1.1
–5.2
–2.1
0.1
–0.4
–0.2
0.3
–13.3
0.4
0.0
0.3
–0.1
0.9
1.1
–1.7
0.4
0.6
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
YTD
Inception
The above risk premiums reflect the return
for investing in a factor portfolio with
one standard deviation of exposure above
the global mean.
QQE6
Source: Morningstar global risk model. © 2017 Morningstar. All Rights Reserved.
15
Morningstar Global Risk Model Factors: Cumulative Returns
Size, controlling for other risk factors, maintains the highest premium over the long term. Momentum lags size due to its severe drawdown during the financial crisis.
Value-growth, on the other hand, tends to outperform during times like these, which is why it may be a good idea to combine value-growth and momentum in a portfolio.
Morningstar Global Risk Model Factors: Cumulative Returns
$2.25
2.00
1.75
1.50
1.00
0.75
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Growth of $1
1.25
17
Trailing 1 Quarter
Trailing 1 Year
Trailing 3 Year
Trailing 5 Year
Trailing 10 Year
Sharpe 10 Year
1.3
2.4
0.5
0.4
1.5
6.3
3.2
2.7
2.0
0.0
6.3
5.7
1.8
2.1
1.0
5.9
6.8
1.8
1.5
0.9
5.6
4.9
2.2
2.1
0.8
0.67
0.33
0.39
0.22
0.06
Factor
Size
Momentum
Value-Growth
Financial Health
Fair Value
QQE7
Source: Morningstar global risk model. © 2017 Morningstar. All Rights Reserved.
16
Morningstar Price to Fair Value by Country
All countries are currently overvalued among the major countries analyzed. Unlike in previous quarters, when international markets were less expensive than the U.S.,
now valuations around the world have converged in overvalued territory, leaving investors little opportunity.
Market-Cap-Weighted Valuation
Russia 3.2
Sweden 12.4
Norway 9.5
Overvalued
10.0
5.1 to 10
1.1 to 5
Fairly Valued
–1.0 to 1.0
U.K. 7.9
Canada 8.8
Germany 6.6
France 7.2
Denmark 6.6
China 7.7
Greece 5.6
United States 6.6
Spain 3.7
Mexico 2.2
Japan 6.3
Italy 8.2
S. Korea 3.7
Egypt 12.3
Thailand 5.9
Colombia 6.8
Peru 12.8
Chile 8.2
Undervalued
–1.1 to –5
–5.1 to –10
–10.0
Regions
%
Greater Asia
5.5
Greater Europe 6.5
United States 6.6
India 5.1
Brazil 6.8
South Africa 3.7
Australia 13.9
New Zealand 2.3
QQE5
Source: Morningstar quantitative and analyst fair value data. ©2017 Morningstar. All Rights Reserved.
17
Morningstar Quantitative Price to Fair Value Distribution, U.S. Equity
Overvalued
The distribution of price to fair value can yield a richer interpretation of market valuation than simple averages. At times, the median U.S. stock may be slightly overvalued, but the range of overvaluation can be substantial. In the first quarter of 2017, U.S. equities started trading above fair value again for the first time since August 2014.
Percentile
150%
90–95
75–90
50–75
25–50
10–25
100
5–10
Median
50
0
Undervalued
–50
–100
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
17
QQE1
Source: Morningstar quantitative and analyst fair value data. ©2017 Morningstar. All Rights Reserved.
18
Morningstar Price to Fair Value, U.S. Equity Style Boxes (%)
On a market-cap-weighted basis, the total market is now overvalued by 6.6% (compared with the previous quarter’s 3.8%). The only exception to that trend is value
stocks, which became slightly cheaper. The most undervalued opportunities in the moat/uncertainty box are in wide-moat stocks, which, on average, are only 2.1% overvalued. Wide-moat/high-uncertainty stocks are the most undervalued, but there aren’t many stocks in that category.
Style
Value
Total
Market 6.6
6.1
Uncertainty
Blend
7.5
Growth
Low
Total
Market 6.6
6.8
8.1
Medium
2.7
High
9.9
Overvalued
10
5 to 10
5.9
4.7
7.9
Wide
Large
Fairly Valued
5.4
2.1
6.2
–0.2
–7.4
0 to 5
0
–5 to –0
12.2
6.0
5.1
5.8
7.2
Narrow
7.2
7.2
8.6
6.0
6.9
None
11.7
Moat
Mid
Size
10.3
Small
Undervalued
14.6
19.5
8.3
16.1
–10 to –5
–10
QQE4
Source: Morningstar quantitative and analyst fair value data. Morningstar Style Boxes based on market-cap-weighted data. ©2017 Morningstar. All Rights Reserved.
19
Morningstar Price to Fair Value Distribution by U.S. Sector
Overvalued
At the end of the first quarter, on a market-cap-weighted basis, real estate was the only sector below fair value. After another quarter of strong returns, basic materials
was the most overvalued sector. In contrast, energy’s weak performance brought it down from extremely overvalued to only moderately so. Valuations for this sector vary
widely because of oil price volatility and high uncertainty about the future prospects of many energy companies.
Percentiles
40%
90th
75th
20
Market-CapWeighted Avg
Median
0
25th
Undervalued
10th
–20
–40
100%
Overvalued
Fairly Valued
Undervalued
75
50
25
0
r
t
y
Basic
Materials
Consumer
Cyclical
Financial
Services
u
Real Estate
i
o
Comm
Services
Energy
p
a
Industrials
Technology
s
d
Consumer
Defensive
Healthcare
f
Utilities
QQE2
Source: Morningstar quantitative and analyst fair value data. ©2017 Morningstar. All Rights Reserved.
20
Morningstar Price to Fair Value Distribution by Region
Overvalued
Morningstar calculates fair values for 53 countries, and only two out of those 53 are currently undervalued. Furthermore, every major region in the world is currently
overvalued.
Percentiles
30%
90th
20
75th
10
Market-CapWeighted Avg
Undervalued
0
Median
–10
25th
10th
–20
North America
Latin America
Europe
UK & Ireland
Africa
Top 10 Lowest-Valued Companies (Market-Cap-Weighted)
Country
Switzerland
Nigeria
Hong Kong
Philippines
Mexico
New Zealand
Turkey
Russia
Vietnam
United Arab Emirates
Over/Undervalued by %
India, Pak, &
Middle East
Asia Pacific
Australia &
New Zealand
Top 10 Highest-Valued Companies (Market-Cap-Weighted)
Uncertainty Rating
Number of Companies
Country
Over/Undervalued by %
Uncertainty Rating
Number of Companies
–0.2
–0.1
0.2
1.0
2.2
Medium
Very High
High
High
High
176
24
1023
167
80
Finland
Bulgaria
Australia
Romania
Peru
19.9
14.2
13.9
13.1
12.8
High
Very High
High
High
High
108
37
449
25
26
2.3
3.2
3.2
3.4
3.6
Medium
High
High
High
High
72
349
102
263
54
Sweden
Egypt
Norway
Belgium
Austria
12.4
12.3
9.5
9.3
9.3
High
Very High
High
High
High
371
152
162
94
48
QQE3
Source: Morningstar quantitative and analyst fair value data. ©2017 Morningstar. All Rights Reserved.
21
Total Yield of S&P 500 Is 4.7%
Companies can reward investors by paying out dividends or—an option sometimes forgotten—buying back their own stock. Dividend yield has been fairly stable over
time at about 2%. Buyback yield has fluctuated a lot more because companies are not compelled to maintain buybacks during tough economic times. The buyback yield
has declined recently and currently stands at 2.6%.
S&P 500 Dividends and Buybacks, Trailing 12 Months
$1,000 Bil
10% Yield
Buybacks
Dividend Paid
Total Yield
Buyback Yield
800
8 Dividend Yield
600
6
400
4
200
2
0
0
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
QE5
Source: Morningstar equity data. © 2017 Morningstar. All Rights Reserved.
22
Fixed Income
The U.S. Treasury Yield Curve Shifted Upward During the Last Year
The Federal Reserve raised interest rates three times in the past 18 months, and the entire yield curve has responded by moving significantly higher. With the dramatic rise
in yields, long-duration bonds took a beating and high-yield bonds were the best performers because of their lower interest-rate risk. Emerging-markets bonds rebounded
from the sell-off after the first U.S. rate increase (which created fears that emerging markets would struggle to repay their debt, made more expensive by a rising dollar).
U.S. Treasury Yield Curve
3.5%
Bonds
Current
3.0
1 Year Ago
2.5
Core
10 Year U.S. Treasury
20 Year U.S. Treasury
Inflation Protected (TIPS)
U.S. Corporate
U.S. High Yield
USD Emerging Market
Local Currency Emerg Mkt
1-Year
Return (%)
0.4
–2.5
–5.2
1.5
3.3
16.4
8.5
5.1
2.0
1.5
1.0
0.5
0
0
Years
5
10
15
20
25
QFI6
Source: U.S. Federal Reserve. 10-Year US Treasury Bonds—Barclays US Treasury 7-10 Year Bond Index. 20+ Year US Treasury Bonds—Barclays US Treasury 20+ Year Bond Index. US Corporate Bonds—Morningstar
Corporate Bond Index. US High Yield Bonds—Barclays US Corporate High Yield Bond Index. US Mortgage Bonds—Morningstar Mortgage Bond Index. USD EM Bonds—Morningstar EM Composite Bond Index. Local
Currency EM Bonds—Barclays EM Local Currency Broad Bond Index. ©2017 Morningstar. All Rights Reserved.
24
United States Has the Highest Yields in the Developed World
Since hitting all-time lows in mid-2016, rates have risen around the world, with the largest rises witnessed in Italy and the U.S. Despite the upward movement, rates are
still at historically low levels, and have only climbed back up to where they were in June 2015. After a stint in negative territory, Germany and Japan now have positive,
although still very low, 10-year yields.
10-Year Government Bond Yields
5%
United States
Italy
United Kingdom
4
France
Germany
Japan
Current
Yield (%)
Change in Last
6 Months (%)
2.4
2.3
1.2
1.0
0.3
0.1
0.6
1.0
–0.3
0.5
0.2
0.1
3
2
1
0
–1
2013
2014
2015
2016
QFI10
Source: Macrobond Financial. ©2017 Morningstar. All Rights Reserved.
25
High-Yield Spreads Continue to Narrow
In less than a year, high-yield credit spreads narrowed from almost 9% to just 4% as many energy bonds rebounded after a bankruptcy scare. With the recent credit rally,
all current spreads are below their long-term historical averages. With dramatic tightening of the high-yield spread came strong returns, but that also means less opportunity going forward.
Corporate Credit Spreads
10%
Change Over
Current (%) Avg (%) Last Quarter
AAA
9
BBB
High Yield
0.7
1.6
4.0
0.8
2.1
5.8
0.0
–0.1
2.4
8
7
6
5
4
3
2
1
0
2010
2011
2012
2013
2014
2015
2016
17
QFI9
Source: Bank of America Merrill Lynch Corporate Spread Indexes from the Federal Reserve, Morningstar calculations. ©2017 Morningstar. All Rights Reserved.
26
What Will Happen to Short-Term Interest Rates?
Projections from the Federal Open-Market Committee and the Wall Street Journal illustrate what those sources think the trajectory of the Fed funds rate will be going
forward. Fed funds futures illustrate what the market thinks the Fed funds rate will be going forward. While all sources believe rates will continue to rise, the market has
lower expectations than the other two sources.
Projections for the Federal Funds Rate from Three Different Sources
Fed Funds Rate
6%
FOMC Projections
WSJ Economists
Survey
5
Fed Funds Futures
4
3
2
1
0
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
QFI14
Source: Federal Reserve, Wall Street Journal, Chicago Mercantile Exchange, Morningstar calculations. © 2017 Morningstar. All Rights Reserved.
27
Most Assets Concentrated in Lower-Duration Bond Funds
Duration is a measure of the sensitivity of bond prices to changes in interest rates. Long-duration bonds tend to be more sensitive to changes in interest rates than
short-duration bonds. As of September 2016, 80% of fixed-income assets were invested in funds with a duration less then 6 years. Funds with a duration greater than 6
years attract fewer assets, which indicates that most investors are risk-averse and avoid placing too large a share of their assets in long-term (more volatile) bonds.
Fixed Income Fund Assets by Duration
100%
75
Range
2 to 4
2
12.3
6 to 8
5 to 6
4 to 5
Percent of Total Market Value
50
Sept. 2016 %
3.0
17.3
33.0
14.8
19.6
8
25
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
QFI11
Source: Morningstar fixed-income fund data. © 2017 Morningstar. All Rights Reserved.
28
The Largest Firms Continue to Attract the Majority of the Flows, with Vanguard Still in the Lead
Most of the time, the top ten fund families get positive annual flows. However, there were some periods in history when one company got particularly hurt by outflows
for an extended period of time. American Funds suffered outflows for six consecutive years after the 2007 crisis because of weak performance, and PIMCO was in outflow
territory for one year before and two years after Bill Gross’ departure in 2014.
Historical Flows into the Top 10 Fund Families
$500 Bil
Vanguard
American Funds
Fidelity
BlackRock/iShares
400
State Street
T. Rowe Price
Franklin Templeton
300
DFA
PIMCO
J.P. Morgan
200
100
0
–100
–200
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
QFF16
Source: Morningstar Direct Asset Flows. © 2017 Morningstar. All Rights Reserved.
29
Funds
Top 20 Mutual Fund Companies by Assets
Less Expensive
There is a relationship between fees and performance. Firms with high fees tend to have below-average performance and are located in the bottom left-hand side of
the chart. Firms with low fees have a higher likelihood of above-average performance, but it isn’t guaranteed. The best firms (closest to the upper right-hand corner) are
Dodge & Cox and American Funds.
DFA
100%
Vanguard
Dodge & Cox
TIAA-CREF
Share Classes Below-Average Fee Level
American Funds
BlackRock
Lord Abbett
J.P. Morgan
Janus
T. Rowe Price
Franklin Templeton
50
PIMCO
Fidelity
Invesco
John Hancock
Oppenheimer
MFS
Principal Funds
Columbia
More Expensive
American Century Investments
0
20%
Fewer Highly Rated Funds
40
60
Assets Rated 4 or More Stars
80
100
More Highly Rated Funds
QMF3
Source: Morningstar Direct. ©2017 Morningstar. All Rights Reserved.
31
Fastest-Growing Fund Families
Edward Jones’ Bridge Builder fund family enjoyed the highest 12-month organic growth rate, driven by its Core Plus bond fund. The Bridge Builder funds are to be used
exclusively in fee-based advisory accounts (available to all Edward Jones financial advisors), a strategy which spurred the recent growth. Schwab has continued to gain
market share because of its low-cost ETF line-up and an efficient distribution system, which offers free trading to Schwab account holders.
Top 10 Fund Families
of the 100 Largest
12-Month Organic Growth Rate of Fund (%)
Contribution of Top-Flowing Fund
Top Fund for Each Family
Morningstar Category
Active/Passive
Bridge Builder
Bridge Builder
Core Plus Bond
Intermediate-Term Bond
Active
Schwab ETFs
Schwab International
Equity ETF
Foreign Large Blend
Passive
Van Eck
VanEck Vectors
Gold Miners ETF
Equity Precious Metals
Passive
Baird
Baird Aggregate Bond
Intermediate-Term Bond
Active
Guggenheim
Guggenheim Total
Return Bond
Intermediate-Term Bond
Active
ALPS
Alerian MLP ETF
Energy Limited Partnership
Passive
Parnassus
Parnassus Endeavor Fund Large Growth
Active
Harding Loevner
Harding Loevner
International Equity
Foreign Large Growth
Active
AQR Funds
AQR Managed
Futures Strategy
Managed Futures
Active
iShares
iShares Core S&P 500
Large Blend
Passive
0
10
20
30
40
50
60
QFF7
Source: Morningstar Direct. ©2017 Morningstar. All Rights Reserved.
32
Top- and Bottom-Performing Morningstar Categories
International-equity categories delivered impressive performance in the first quarter, driven by India, Latin America, and Pacific/Asia ex-Japan. Investors seem less worried about the U.S. administration’s anti-trade statements and more optimistic about emerging markets’ future growth potential. China’s growth in the first quarter was
better than expected. Only three Morningstar categories had negative returns in the first quarter, two of those because of the drop in oil prices.
Trailing Quarter Flows ($ Bil)
Trailing Quarter Returns (%)
Allocation
Alternative
Commodities
International Equity
Municipal Bond
Sector Equity
Taxable Bond
U.S. Equity
–20
0
20
40
60
80
100
120
–2
0
2
Return (%)
4
6
8
10
Return (%)
Top-Performing
Morningstar Categories
U.S. Category Group
Trailing
Quarter
Trailing
1 Year
Quarterly
Flow ($ Mil)
Bottom-Performing
Morningstar Categories
U.S. Category Group
India Equity
Latin America Stock
Pacific/Asia ex-Japan Stk
Technology
China Region
International Equity
International Equity
International Equity
Sector Equity
International Equity
20.2
13.8
13.0
12.4
12.2
28.6
25.9
15.9
26.6
17.3
Diversified Emerging Mkts
Commodities Precious Metals
Equity Precious Metals
Diversified Pacific/Asia
Foreign Large Growth
International Equity
Commodities
Sector Equity
International Equity
International Equity
11.6
10.9
9.8
9.4
9.2
16.2
14.2
20.1
14.4
8.7
Trailing
Quarter
Trailing
Quarterly
1 Year Flow ($ Mil)
597
936
353
4,047
–471
Bear Market
Equity Energy
Commodities Broad Basket
Managed Futures
Short Government
Alternative
Sector Equity
Commodities
Alternative
Taxable Bond
–9.8
–5.8
–2.0
0.1
0.3
–26.6
18.7
8.8
–4.5
–0.1
295
–600
245
–155
694
13,577
–2,411
2,920
365
–1,601
Small Value
Ultrashort Bond
Intermediate Government
Short-Term Bond
Market Neutral
US Equity
Taxable Bond
Taxable Bond
Taxable Bond
Alternative
0.3
0.4
0.5
0.6
0.6
23.4
1.5
–0.6
1.7
2.3
3,028
12,579
–1,173
7,768
146
20
10 to 20
0 to 10
–10 to 0
–20 to –10
–20
QMF10
Source: Morningstar Direct. ©2017 Morningstar. All Rights Reserved.
33
Passive Investing Is Starting to Catch on Outside the U.S.
Fixed-income flows were positive across all global regions analyzed in 2016, proving that investors still love bonds, either active or passive. In equity, the trend that started
in the U.S. (favoring passive over active) seems to have caught on in Cross-Border and European funds, too. Asian investors were the only ones to maintain active equity
flows in positive territory.
2016 Flows for Passive and Active Funds in Major Regions by Asset Class
$400 Bil
Equity Passive
Equity Active
Fixed Income Passive
300
Fixed Income Active
200
100
0
–100
–200
–300
–400
United States
Cross-Border
Europe
Asia
QFF15
Source: Morningstar Direct Asset Flows. ©2017 Morningstar. All Rights Reserved.
34
Passive Investors Get Higher Total Returns and a Lower Return Gap
Investor returns take into account monthly fund flows and monthly returns to estimate a typical investor’s experience in a fund. Over the past 10 years, investor returns in
most fee levels lagged total returns because investors are notoriously bad market timers. However, the lower the fees, the shorter the return gap. In other words, investors who choose less expensive funds tend to market-time less and are therefore less likely to miss out on a fund’s potential returns.
Morningstar Fee Level—
Active/Passive
10-Year Investor Return  10-Year Total Return  Return Gap
3.5
High Fee—Active
1.6
–2.0
4.1
Above Avg.—Active
2.7
–1.5
4.7
Avg. Fee—Active
–1.5
3.2
5.0
Below Avg. Fee—Active
3.8
–1.3
5.0
Low Fee—Active
3.8
–1.2
5.7
Passive
5.1
0.0%
Average 10-Year Returns
1.0
2.0
3.0
4.0
5.0
–0.5
6.0
QMF13
Source: Morningstar Direct. © 2017 Morningstar. All Rights Reserved.
35
Closed-End Funds Statistics
All closed-end fund categories are currently trading below fair value. A good buying opportunity is generally when a fund has a z-score of negative 1, indicating that its
discount is one standard deviation away from its three-year average. Currently no category looks attractive because they all have positive z-scores. Unlike the mutual fund
market, the closed-end-fund market can grow only through new IPOs, and recently there have been fewer and fewer of these, both in number and size.
Broad Category
Allocation
Commodities
International Equity
U.S. Equity
U.S. Sector Equity
Taxable Bond
Municipal Bond
3-Year
Z-Statistic
Current Avg.
Discount (%)
Avg. Distribution
Rate (%)
Number of
IPOs in 2017
Total Assets
($ Mil)
% of Funds
Using Leverage
3-Month Total
Return (%)
1-Year Total
Return (%)
1.1
0.2
1.0
0.6
0.9
1.1
0.3
–7.1
–1.6
–7.7
–7.9
–4.0
–3.1
–3.4
8.0
0.0
5.0
7.5
8.0
7.3
4.9
0
0
0
0
0
3
0
21,414
6,808
13,504
15,880
36,215
73,018
62,919
78
0
27
52
80
87
95
5.2
11.0
10.1
5.1
4.6
3.5
2.0
15.4
11.4
13.7
16.3
29.1
15.4
–0.2
Closed-End Fund Market Size and Number of IPOs Annually
$30 Bil
90
25
75
20
60
15
45
10
30
5
15
0
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
2011
2012
2013
2014
2015
2016
CEF New
Issuance
# of Fund IPOs
2017
QCEF1
Source: Morningstar Direct. The z-statistic result is the number of standard deviations away from the average discount over the time period measured. Z-statistic = (Current discount–Average discount)/Standard
deviation of discount. ©2017 Morningstar. All Rights Reserved.
36
Economic Indicators
After Five-Quarter Slide, Year-Over-Year GDP Growth Stabilizes at Low Levels
After bottoming at a measly 1.3% gross domestic product growth rate in late 2016, growth has recovered modestly and stabilized between 1.7% and 1.9%. That is still
well below the 60-year average of 3.1% and even the lackluster 2.1% rate for the current recovery. In fourth-quarter 2016, consumer spending accounted for all of the
economic growth, with little to no help from government, investment, or net exports.
Quarterly Year-Over Year GDP Growth
GDP Breakdown: $16,813 Bil
4%
Category
%
17.1
Government
17.6
Consumption 69.4
Net Exports
–3.6
Investment
3
GDP Growth Contributions
Total Growth 2.0%
1.9%
Growth
2
Category
%
Investment
1
2
Government
Consumption
Net Exports
109
–12
1
0
Q1
2012
Q2
Q3
Q4
Q1
2013
Q2
Q3
Q4
Q1
2014
Q2
Q3
Q4
Q1
2015
Q2
Q3
Q4
Q1
2016
Q2
Q3
Q4
Q1
2017
QEI7
Source: Bureau of Economic Analysis, Morningstar calculations. Percentage breakdowns might not add up to their totals because of rounding differences. ©2017 Morningstar. All Rights Reserved.
38
Microeconomic Data by Sector Doesn’t Look Nearly So Bullish
The latest economic recovery has been quietly driven by a handful of sectors, few of which have been broadly recognized, at least until recently. Autos, aerospace, and
oil production have been important drivers, but those sectors have been crashing back to earth. Now, even healthcare (Affordable Care Act transition nearing completion)
and restaurant (slower employment growth, cheaper groceries) spending has slowed, too. Easy replacements are not evident.
Key Economic Drivers, Year-Over-Year Growth Rate, Rolling 12-Month Average
Health Care
15.0%
Restaurants
Motor Vehicles
12.5
Aerospace
Oil and Gas
10.0
7.5
5.0
2.5
0.0
–2.5
–5.0
2012
2013
2014
2015
2016
2017
QEI64
Source: Federal Reserve, Bureau of Economic Analysis. © 2017 Morningstar. All Rights Reserved.
39
Consumption, at 70% of GDP, Looking Tired as Wherewithal and Desire to Spend Both Pressured
Consumption growth has slowed recently, driven by slower wage and income data. Potentially, consumption could slow further in 2017 as inflation continues to eat away
at consumer incomes. That is especially true for the 63 million people collecting under at least one of several Social Security programs. Those benefit checks have seen
almost no increase in two years, and the next potential for an increase isn’t until 2018.
6%
4
Consumption
Wages
Disposable Income
Year-Over-Year Change, 3-Month Average
2
0
–2
–4
2012
2013
2014
2015
2016
2017
QEI3
Source: Bureau of Economic Analysis. ©2017 Morningstar. All Rights Reserved.
40
Rapidly Closing Gap Between Hourly Wages and All Items CPI Likely to Slow Consumption Growth
Hourly wage growth opened a very wide gap over all items inflation in late 2014, helping drive consumption (not shown) higher in 2014 and 2015. While still healthy,
consumption growth slowed in 2016 as the gap between hourly wages and inflation closed modestly. Without the benefits of rapidly falling energy prices in 2017, we
suspect all items inflation will converge with core inflation rates and hourly wage growth, potentially further depressing consumption in 2017.
Consumer Price Index vs. Wage Growth
Avg. Hourly
Earnings
3.0%
Core CPI
2.5
All Items CPI
2.0
Year-Over-Year Change, 3-Month Average
1.5
1.0
0.5
0.0
–0.5
Jan
2013
Jul
Jan
2014
Jul
Jan
2015
Jul
Jan
2016
Jul
Jan
2017
QEI5
Source: Bureau of Labor Statistics, Morningstar calculations. ©2017 Morningstar. All Rights Reserved.
41
Consumption Growth Slowing in Many Categories, but No Obvious Collapses Either
Category growth in 2017 looks slower than in 2016. Four of the 12 consumption categories grew much faster than they did last year. The winners were education, financial services, furniture, and recreational spending. The two largest categories, housing and healthcare (combined, over 50% of consumption) are down just modestly,
limiting the damage from slowdowns elsewhere. Still, saturation issues and changing tastes are popping up (autos, TVs, cell phones).
Real Consumption Categories
Ending Feb 2017
Ending Feb 2016
Clothing
Communications
Education
Financial Services
Furniture
Groceries
Healthcare
Hotel & Restuarant
Housing & Utilities
Other
Recreation
Transportation
1
0
% Change Year Over Year, 3 Month Average
2
3
4
5
6
QEI43
Source: Bureau of Economic Analysis. © 2017 Morningstar. All Rights Reserved.
42
Employment Growth Has Been Slowing Since Early 2015, Limiting Income Growth and Spending
Total nonfarm payroll growth has slowed from a high of 2.2% to just 1.6%, mirroring the slowdown in GDP and consumption growth. Both GDP and employment growth
appear to be stabilizing, though consumption growth still looks vulnerable, especially in first-quarter 2017. Slow employment growth appears to be more of a function of
few available workers than a shortage of jobs in many industries. However, declining brick-and-mortar retail jobs aren’t helping job growth data.
U.S. Employment Growth Since 2010
Private Sector
3%
Total Nonfarm
Year-Over-Year Change, 3-Month Average
2
1
2012
2013
2014
2015
2016
2017
QEI13
Source: Bureau of Labor Statistics, Morningstar calculations. ©2017 Morningstar. All Rights Reserved.
43
Stabilizing Year-Over-Year U.S. GDP Growth Rates Suggest Total Employment Hours Should Improve
Nongovernment GDP growth tends to lead total payroll hours worked data (number of workers times average hours). With rolling 12-month GDP growth increasing again
in December 2016 and likely to increase again in the first quarter, we believe that hours worked data should stop falling shortly. Productivity, defined as the difference
between GDP growth and total hours worked, will move over 0.5% in Q1 following a brief period when GDP growth trailed the hours data.
GDP vs. Total Hours Worked
Non-Govt GDP
3.50%
Total Private
Hours Worked
3.25
3.00
2.75
2.50
2.25
% Change, Year Over Year
2.00
1.75
1.50
1.25
Jan
2012
Jul
Jan
2013
Jul
Jan
2014
Jul
Jan
2015
Jul
Jan
2016
Jul
Jan
2017
QEI59
Source: Bureau of Labor Statistics, Bureau of Economic Analysis. © 2017 Morningstar. All Rights Reserved.
44
Job Openings Growth Approaching Zero as Businesses Become Discouraged
After soaring, job openings are now little changed compared with a year ago as businesses cope with slower growth, worker shortages, and skills mismatches. Some
businesses have decided to forgo growth, while others are trying to find ways around employment bottlenecks. Some employers are doing more training, while others are
investing in more equipment. Still, the falling growth in openings is not a great omen for employment growth, as shown below.
Employment vs. Job Openings, % Change, Year-Over-Year, 3-Month Average
30% Total Nonfarm
Employment, Ihs
3%
Job Openings, rhs
2
20
1
10
0
0
–1
–10
–2
–20
–3
–30
–4
–40
–5
–50
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
17
QEI69
Source: Bureau of Labor Statistics. © 2017 Morningstar. All Rights Reserved.
45
Immigration Will Be Key to Population Growth as Native Born Population Growth Shrivels
Population and productivity growth are the two key drivers of GDP growth. In the 1950s and 1960s, natural population growth (births less deaths) dominated total population growth as a result of all the baby boomer births. As that era passed, immigrants became a larger part of population growth. In 2017, natural and immigrant population growth are projected to account for 1.4 million and 1.2 million of growth, respectively. By 2050, that flips to 0.4 million and 1.4 million.
Components of Population Growth
Net Immigration
3.5 Mil
Internal Population
3.0
2.5
2.0
1.5
1.0
0.5
0
1950
1970
1990
2010
2030
2050
QEI76
Source: U.S. Census Bureau, Morningstar Calculations © 2017 Morningstar. All Rights Reserved.
46
Immigration Helps Offset Slowing Natural Population Growth, Helping Grow the Labor Force
Foreign-born residents have continued to grow as a percentage of the population as immigration rates hold steady and natural population growth (births minus deaths)
continues to diminish. Still, at 13%, the immigrant population remains below the 13.2% to 14.7% rate of the late 1800s. Between 1960 and 2015, immigration shifted from
Europe to Latin America and more recently to Asia. Asians represent over 50% of immigrants since 2010 (not shown).
Foreign-Born Population in the U.S.
# of ForeignBorn People
$50 Mil
40
% of Total
Population
30
20
10
0
1850
1860
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
2010
2015
Where Foreign-Born Americans Came From: 1960 vs. 2015
80%
1960
2015
60
40
20
0
Europe
North America
Latin America
Asia
Other
QEI74
Source: U.S. Census Bureau, Morningstar Calculculations © 2017 Morningstar. All Rights Reserved.
47
Foreign-Born Population Percentage Has Increased in 48 of the 50 States Since 1960
While the foreign born have increased as a percentage in almost every state, progression in some Southern and Western states has been dramatic. In many cases, those
have been the states where economic growth has generally been higher than average. In California, the foreign-born population, already a high 9% in 1960, jumped 18%
to 27% in 2015. Four states, representing 30% of the total U.S. population, have an immigrant population greater than 20%.
Change in Foreign-Born Population as a Percentage of Total (2015 minus 1960)
–5 to 0
0 to 4.9
5 to 9.9
10 to 14.9
15 to 20
QEI75
Source: U.S. Census Bureau, Morningstar Calculations © 2017 Morningstar. All Rights Reserved.
48
Stronger Growth in Consumer Net Worth Could Help Offset Slower Employment Growth
Ever-increasing home prices with a generally positive stock market have pushed consumer net worth to an all-time high at over $90 trillion. While growth in net worth has
diminished, it still looks to contribute to consumer spending growth, with net worth increasing over 7% in the most recently available data. The question is, will consumers spend that extra cash or sit on it?
Household Net Worth
$100 Tril
20% Net Worth Level, Ihs
90
Net Worth,
16 Year-Over-Year, rhs
80
12
70
8
60
4
50
0
40
–4
30
–8
20
–12
10
–16
0
–20
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
QEI68
Source: Federal Reserve. © 2017 Morningstar. All Rights Reserved.
49
Low Mortgage Rates and Mortgage Paydowns Have Greatly Reduced Monthly Fixed Payments
The financial obligations ratio compares required monthly consumer payments (rent, mortgage, motor vehicle, and credit card payments) with incomes. Cash going to
those fixed payments remains at a near-record low, about 15.5% of incomes. That should give consumers a little more firepower to spend on other goods and services,
potentially blunting the impacts of slower real wage growth.
Financial Obligations Ratio (FOR)
18.5
18.0
17.5
17.0
16.5
16.0
15.5
15.0
14.5
14.0
1980
1985
1990
1995
2000
2005
2010
2015
QEI70
Source: U.S. Federal Reserve © 2017 Morningstar. All Rights Reserved.
50
Real Estate Price Growth Steady at 6.2%, West Cools While the Rest of the Country Accelerates
Moderate home price growth of 6.2% in Q4 2016 versus 6.1% in Q3 belies sharply slowing prices in the Bay area, 7.1% to 1.1%, and a 3.8% to 7.8% increase in Chicago.
Home price appreciation is no longer a Western- and Southern-based phenomenon, with Midwestern and Eastern markets now participating. A broader geographic
scope of price increases may be driving improved consumer sentiment and is better for the economy than the lopsided results early in the recovery.
Year-Over-Year Price Growth
Growth (%)
United States: 6.2
12.2
0 to 5.9
Seattle
6 to 10.9
11.2
11 to 15
Portland
Detroit
7.8
Denver
10.3
1.1
Chicago
8.2
Las Vegas
6.2
6.2
Indianapolis
6.2
Pittsburgh
4.7
≤250
Boston
3.5 New York
7.6
Philadelphia
2.6
4.9 Baltimore
5.4 Cincinnati
St. Louis
Nashville
9.7
Los Angeles
6.0
Kansas City
San Francisco
2.0 San Jose
7.8
Median House Price ($k)
Cleveland
251 to 500
≥501
Washington
Charlotte
9.1
9.5
6.8
7.7
7.9
Phoenix
10.7
San Diego
Dallas
8.6
Atlanta
Austin
10.1
9.3
3.3
Houston
7.3
Orlando
San Antonio
10.9
Miami
QEI2
Source: Federal Housing Finance Agency, National Association of Realtors, Zillow. ©2017 Morningstar. All Rights Reserved.
51
Manufacturing Sector Improvement Might Offset Some Consumption Issues
The manufacturing sector shrank in 2016 overall, buffeted by issues related to the slowing energy and drilling sectors. The maturing auto and aerospace sectors compounded those problems. Now, with drilling and commodity prices stabilizing, investment in these sectors has improved, moving the manufacturing sectors into positive
territory in 2017. Improved new-order books suggest that manufacturing may grow by as much as 2% in 2017.
Durable Goods Orders vs. Industrial Production, Year-Over-Year, 3-Month Average
4.0%
12% New Orders,
Durable Goods
Ex-Transport, rhs
10
Industrial Production
Manufacturing, Ihs
3.5
3.0
8
2.5
6
2.0
4
1.5
2
1.0
0
0.5
–2
0.0
–4
–0.5
–6
–1.0
–8
Jan
2012
Jul
Jan
2013
Jul
Jan
2014
Jul
Jan
2015
Jul
Jan
2016
Jul
Jan
2017
QEI71
Source: U.S. Federal Reserve and U.S. Census Bureau © 2017 Morningstar. All Rights Reserved.
52
Slowing Imports Limiting Damage From Slowing Exports, Potentially Limiting 2017 GDP Damage
Late in a recovery, net exports are usually a meaningful detractor from GDP growth. However, rising U.S. energy production, a shift in consumer preferences to experiences over goods, and preferences for motor vehicles produced in NAFTA countries have combined to make import growth look nearly as pathetic as exports. Rising U.S.
services exports have also been a help.
U.S. Imports and Exports as a Percentage of Gross Domestic Product
Recession
16%
Imports, Services
Imports, Goods
14
Exports, Services
Exports, Goods
12
10
8
6
4
2
0
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
QEI53
Source: Bureau of Economic Analysis, National Bureau of Economic Research. © 2017 Morningstar. All Rights Reserved.
53
Most Healthcare Payments Made by Government and Intermediaries
Since 1960, individuals’ share of payments has dropped from over 50% to just over 10%; meanwhile, government’s share has moved from nothing in 1960 (before Medicaid and Medicare started) to over 40%. That means that healthcare spending will become the single biggest factor in an expanding Federal budget deficit in the two
decades ahead, dwarfing Social Security as an issue.
Healthcare Spending by Payor
100%
Other
Medicaid
Medicare
90
Private Health
Insurance
80
Out of Pocket
70
60
50
40
30
20
10
0
1960
1970
1980
1990
2000
2010
2020
QEI72
Source: Center for Medicare and Medicaid Services. © 2017 Morningstar. All Rights Reserved.
54
Higher Per Capita Healthcare by Age and Greater Government Involvement Spell Budget Issues
Healthcare expenses for 19- to 44-year-olds are a manageable $5,000 per year. However, at age 65, when Medicare kicks in, that rises more than three-fold to about
$17,000, and it is over $30,000 for an 85-year-old. The lower graph shows a population growth rate of less than a half percent for the inexpensive under-65-year-olds and
about 3% for those over age 65. Because most individuals over 65 are covered by Medicare, this becomes a big headache for government deficits.
Per Capita Spending by Age Group
Under 65
$35K
65 or Over
30
25
20
15
10
5
0–18
19–44
45–65
66–84
85
Population by Age
Under 65
5
65 or Over
Year Over Year % Change
4
3
2
1
0
2010
2015
2020
2025
QEI73
Source: Centers for Medicare and Medicaid Services, U.S. Census Bureau © 2017 Morningstar. All Rights Reserved.
55
Presidential Election and Potential Policy Moves Created Market Winners and Losers
As new federal government policies have been slow in coming, several postelection winners have lost some momentum and some of the big losers are now back in the
black. For example, the U.S. financials sector was up as much as 25% on hopes of the roll-back of new financial regulations. As those actions have slowed, gains are back
under 20%. Emerging markets that were down 7% are now up 7% as trade proposals were less radical than expected.
Performance of Major Indexes After the U.S. Presidential Election
25%
U.S. Presidential Election
20
U.S. Financial Sector
15
Small Cap Stocks
Large Cap Stocks
10
Emerging Mkts Stocks
5
EM Debt/
Local Currency
0
Gold
–5
–10
–15
Oct
2016
Nov
Dec
Jan
2017
Feb
Mar
QEI65
Source: Morningstar indexes. © 2017 Morningstar. All Rights Reserved.
56
IMF Projecting Increase in World Growth in 2017 Led by Commodity Producers and India
The IMF is forecasting world growth of 3.5% for 2017--an increase from 3.1% in 2016. The IMF has tended to be too optimistic, though. For example, the IMF predicted
2016 growth at 3.4%; that turned out to be just 3.1%. For 2017, commodity producers, including the U.S., Russia, and Brazil, are expected to benefit from rising commodity prices. Aging demographics are likely hurting the EU, Japan, and even China, while India should benefit from more young workers.
GDP Growth Projections (%)
Russia 1.1 1.2
Projections
Region 2017 2018
World Output 3.4 3.6
Euro Area 1.6 1.6
China 6.5 6.0
United States 2.3 2.5
Japan 0.8 0.5
Brazil 0.2 1.5
India 7.2 7.7
QEI16
Source: International Monetary Fund. © 2017 Morningstar. All Rights Reserved.
57
Chinese Debt Issues Gaining More Attention
The Bank for International Settlements calculates a credit/GDP gap, the most recent ratio of liabilities to GDP growth rates compared with historical norms. When the gap
exceeds 10%, a financial crisis generally ensues within three years. Although the lag periods between signal and banking crisis have been highly variable, the ratio has
predicted most major banking crises in individual countries during the past three decades. China’s reading has been over 10% since 2013.
China Credit to GDP Gaps
2003 Recapitalization of Bank of
China and China Construction Bank
30%
2010 Chinese banks raised
equity and slowed loan growth
20
Danger Zone
10
0
–10
2000
2001
2002
2003
2004
2005
U.S., 2008 Financial Crisis
2006
2007
2008
2009
2010
2011
2012
Argentina, 2002 Financial Crisis
33.2
26
–16
–12.4
–13.2
2000
2005
2010
2015
1995
Ireland, 2010 EU and IMF Bailout of Ireland
2000
2005
2010
1995
Malaysia, 1997 Asian Financial Crisis
29.9
13.2
–28
–32.4
–13.1
2008
2012
1990
1995
2015
2016
2000
2000
2005
2010
2015
Mexico, 1995 Peso Crisis
88
2004
2014
Greece, 2010 Greek Depression
12.4
1995
2013
2005
1992
1996
2000
QEI63
Source: The Bank for International Settlements. © 2017 Morningstar. All Rights Reserved.
58
Index and Disclosure
Index Definitions
The Morningstar Style index family consists of 16 indexes that track the U.S. equity
market by capitalization and investment style to create an integrated system. The
indexes were built using a comprehensive and non-overlapping approach based on the
methodology of Morningstar Style Box.
The Morningstar Sector index family consists of 14 indexes—three Super Sector
and 11 Sector indexes that track the U.S. equity market using a consumption based
analysis of economic sectors in a comprehensive, non-overlapping structure. The
sector indexes are consumer defensive, healthcare, utilities, basic materials, consumer
cyclical, financial services, real estate, communications services, energy, industrials,
and technology.
The Morningstar Global Equity indexes offer a consistent view of global investment
opportunities by applying the same rules for every market around the world. Covering
97% of stocks by market capitalization, the indexes encompass 45 countries in both developed and emerging markets. The index family is designed to work as an integrated
system, allowing for meaningful global views across market capitalization and regions.
The Morningstar Target Risk index family is designed to meet the needs of investors
who would like to maintain a target level of equity exposure. The index family provides
global equity market risk levels that are scaled to fit five equity market risk profiles: aggressive, moderately aggressive, moderate, moderately conservative, and conservative.
The Barclays U.S. Aggregate Bond index is a broad-based benchmark that measures
theinvestment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The
index includes Treasuries, government-related and corporate securities, MBS (agency
fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency).
The Barclays U.S. 5–10 Year Corporate Bond index measures the investment return
of U.S. dollar denominated, investment-grade, fixed rate, taxable securities issued by
industrial, utility, and financial companies with maturities between 5 and 10 years.
The BofA Merrill Lynch US High Yield Master II Index tracks the performance of
US dollar denominated below investment grade corporate debt publicly issued in the
US domestic market. Qualifying securities must have a below investment grade rating
(based on an average of Moody’s, S&P and Fitch).
The Barclays Municipal Bond index measures the broad market for investment
grade, tax-exempt bonds with a maturity of at least one year.
The JP Morgan EMBI Global Diversified index tracks the performance of dollar-denominated sovereign bonds issued by a selection of emerging market countries. The index limits the weights of countries with larger debt stocks by only including a specified
portion of these countries’ eligible current face amounts of debt outstanding.
The London Fix Gold PM index is the price of gold per ounce at 15:00 GMT determined by the five members of the London Gold Pool.
The S&P 500® index includes 500 leading companies and captures approximately 80%
coverage of available market capitalization.
The Bloomberg Commodity index represents 20 commodities, which are weighted for
economic significance and market liquidity.
The Russell 2000 index measures the performance of the 2,000 smallest companies in
the Russell 3000 index.
The Bloomberg Livestock index reflects the returns of an unlevered investment in futures contracts on livestock commodities. The index consists of two commodity futures
(lean hogs and live cattle).
The MSCI EAFE index captures the returns of large and mid-cap equities across developed markets in Europe, Australasia, and the Far East, excluding the U.S. and Canada.
The MSCI Emerging Markets index captures the returns of large and mid-cap equities across 23 emerging markets countries. The index covers approximately 85% of the
free float-adjusted market capitalization in each country.
The Bloomberg Grains index reflects the returns of an unlevered investment in futures contracts on precious metals commodities. The index consists of three commodity
futures (corn, soybeans, and wheat).
The Bloomberg Precious Metals index reflects the returns of an unlevered investment in futures contracts on livestock commodities. The index consists of two commodity futures (gold and silver).
60
The Bloomberg Industrial Metals index reflects the returns of an unlevered investment in futures contracts on industrial metals commodities. The index consists of four
commodity futures (copper, aluminum, zinc, and nickel).
The Bloomberg Energy index reflects the returns of an unlevered investment in
futures contracts on energy commodities. The index consists of five commodity futures
(natural gas, WTI crude oil, Brent crude oil, unleaded gasoline, and heating oil).
The Morningstar® Long-Only Commodity index is a fully collateralized commodity
futures index that is long all 20 eligible commodities and uses a dollar weighted open
interest weighting scheme.
The Brent Crude Oil index tracks the spot price of Brent Crude oil.
The Morningstar U.S. Market index covers the top 97% market capitalization of the
U.S. equity markets.
The Morningstar Developed Ex U.S. index captures the performance of the stocks
located in the developed countries across the world. Stocks in the index are weighted
by their float capital, which removes corporate cross ownership, government holdings
and other locked-in shares.
The Morningstar Emerging Markets index captures the performance of the stocks
located in the emerging countries across the world. Stocks in the index are weighted
by their float capital, which removes corporate cross ownership, government holdings
and other locked-in shares.
The Morningstar Core Bond index is a broad investment-grade index that includes
the largest, most important sectors of the investment-grade U.S. bond market. The
index is comprised of the Morningstar US Government Bond, US Corporate Bond and
US Mortgage Bond indexes.
The Morningstar Intermediate U.S. Government Bond index includes U.S. Treasury
and U.S. government agency bonds with maturities between four and seven years. The
Morningstar Intermediate Corporate Bond index includes U.S. corporate bonds with
maturities of between four and seven years.
The Morningstar U.S. Corporate Bond index includes U.S. corporate bonds with
maturities of more than one year and at least $500 million outstanding.
The Morningstar Short-Term Core Bond index includes all bonds in the Morningstar
Core Bond Index that have maturities between one and four years.
The Morningstar Emerging Markets Composite Bond index includes the most liquid
sovereign and corporate bonds issued in U.S. Dollars (USD) by the governments and
corporations of the most prominent emerging markets.
The Morningstar U.S. Mortgage Bond index tracks approximately 98% of the fixedrate mortgages issued by Ginnie Mae, Fannie Mae and Freddie Mac.
The Morningstar Long-Term U.S. Government Bond index includes U.S. Treasury
and U.S. Government Agency bonds with maturities of seven years or longer.
The Morningstar Long-Term Corporate Bond index includes U.S. corporate bonds
with maturities of seven years or longer.
The Barclays U.S. Corporate High Yield index represents the universe of fixed rate,
non-investment grade debt.
The Barclays U.S. Corporate High Yield ex-Energy index represents the universe of
fixed rate, non-investment grade debt not in the energy sector.
The Barclays U.S. Treasury 7-10 Year Bond index measures the performance of U.S.
Treasury securities that have a remaining maturity of at least seven years and less than
ten years.
The Barclays U.S. Treasury 20+ Year Bond index represents the performance of U.S.
Treasury securities that have a remaining maturity of greater than 20 years.
The Barclays Emerging Markets Local Currency Broad Bond index represents
the performance of the sovereign, local currency bond markets of emerging market
countries. The Barclays Municipal Bond index is representative of the broad market for
investment grade, tax-exempt bonds with a maturity of at least one year.
The Citigroup WGBI Non-USD 5+ Year Bond index measures the performance of
fixed-rate, local currency, investment grade sovereign bonds. It comprises debt from
over 20 countries.
The S&P/LSTA Leveraged Loan index tracks the universe of syndicated leveraged
loans.
61
The MSCI China A Local Currency index captures large and mid-cap equities listed
on the Shanghai and Shenzhen exchanges.
Disclosures
Past performance is no guarantee of future results. This is for illustrative purposes only
and not indicative of any investment. The information, data, analyses, and opinions
presented herein do not constitute investment advice, are provided solely for informational purposes, and therefore are not an offer to buy or sell a security or invest in a
specific asset class or strategy. An investment cannot be made directly in an index. The
data assumes reinvestment of all income and does not account for taxes or transaction
costs. Diversification does not eliminate the risk of experiencing investment losses.
Holding a portfolio of securities for the long-term does not ensure a profitable outcome, and investing in securities always involves risk of loss.
Risk and return are measured by standard deviation and compound annual return,
respectively. Standard deviation measures the fluctuation of returns around the arithmetic average return of the investment. The higher the standard deviation, the greater
the variability (and thus risk) of the investment returns.
Stocks are not guaranteed and have been more volatile than the other asset classes.
Small company stocks are more volatile than large company stocks and are subject to
significant price fluctuations, business risks, and are thinly traded.
Government bonds and Treasury bills are guaranteed by the full faith and credit
of the United States government as to the timely payment of principal and interest.
Bonds in a portfolio are typically intended to provide income and/or diversification. U.S.
government bonds may be exempt from state taxes and income is taxed as ordinary
income in the year received. With government bonds, the investor is a creditor of the
government.
With corporate bonds an investor is a creditor of the corporation and the bond is
subject to default risk. Corporate bonds are not guaranteed.
High-yield corporate bonds exhibit significantly more risk of default than investment
grade corporate bonds.
Only insured municipal bonds are guaranteed as to the timely payment of principal
and interest by issuer. However, insurance does not eliminate market risk. A municipal
bond investor is a creditor of the issuing municipality and the bond is subject to default
risk. Municipal bonds may be subject to the alternative minimum tax (AMT) and state
and local taxes, and federal taxes would apply to any capital gains distributions.
International bonds are not guaranteed. With international bonds the investor is a
creditor of a foreign government or corporation. International investments involve
special risks such as fluctuations in currency, foreign taxation, economic and political
risks, liquidity risks, and differences in accounting and financial standards.
International stocks involve special risks such as fluctuations in currency, foreign
taxation, economic and political risks, liquidity risks, and differences in accounting and
financial standards. Liquidity is typically lower in emerging markets than in developed
markets. The risk of principal and return may be significantly greater than that of other
developed international markets.
Sector investments are narrowly focused investments that typically exhibit higher volatility than the market in general. Sector investments will fluctuate with current market
conditions and may be worth more or less than the original cost upon liquidation.
Growth and value stocks: Although value stocks have outperformed growth stocks,
please keep in mind that each type of stock carries unique risks which include, but are
not limited to, economic risk, market risk, company risk, and strategy risk.
Gold/commodity investments will be subject to the risks of investing in physical commodities, including regulatory, economic and political developments, weather events,
natural disasters, and market disruptions. Exposure to the commodities markets may
subject the investment to greater volatility than investments in more traditional securities, such as stocks and bonds.
Holders of preferred stock are usually guaranteed a dividend payment and their
dividends are always paid out before dividends on common stock. In event that the
company fails, there’s a priority list for a company’s obligations, and obligations to
preferred stockholders must be met before those to common stockholders. On the
other hand, preferred stockholders are lower on the list of investors to be reimbursed
than bondholders are.
62
Mutual funds are sold by prospectus, which can be obtained from your financial professional or the company and which contains complete information, including investment objectives, risks, charges and expenses. Investors should read the prospectus
and consider this information carefully before investing or sending money.
Holding an exchange-traded fund does not ensure a profitable outcome and all investing involves risk, including the loss of the entire principal. Since each ETF is different,
investors should read the prospectus and consider this information carefully before
investing. The prospectus can be obtained from your financial professional or the ETF
provider and contains complete information, including investment objectives, risks,
charges and expenses. ETF risks include, but are not limited to, market risk, market
trading risk, liquidity risk, imperfect benchmark correlation, leverage, and any other
risk associated with the underlying securities. There is no guarantee that any fund will
achieve its investment objective. In addition to ETF expenses, brokerage costs apply.
Fees are charged regardless of profitability and may result in depletion of assets.
Credit/default risk: Debt securities are subject to credit/default risk, which is the risk
associated with the issuer failing to meet its contractual obligations either through a
default or credit downgrade.
Interest-rate risk: Debt securities have varying levels of sensitivity to changes in
interest rates. In general, the price of a debt security tends to fall when interest rates
rise and rise when interest rates fall. Securities with longer maturities and mortgage
securities can be more sensitive to interest rate changes.
This publication contains certain forward-looking statements which involve known
and unknown risks, uncertainties, and other factors that may cause the actual results
to differ materially from any future results expressed or implied by those projected
statements. Past performance does not guarantee future results.
63