Asset Allocation

Ryan Lewenza, CFA, CMT, Private Client Strategist

Q1/15 Update

The Investment Policy Committee (IPC) made no changes to our recommended

asset allocation profiles at our quarterly meeting. We continue to recommend
an overweight in equities and an underweight in bonds and cash.

May 26, 2015

Equity Market YTD Returns (%)

S&P/TSX Comp
S&P/TSX Small Cap

Recently, global bond yields have surged higher with Germany and US 10-year
government bond yields up 53 and 35 bps, respectively since mid-April. We
have been calling for higher bond yields this year based on our expectations for
stronger global growth and the US Federal Reserve (Fed) hiking rates sometime
this year. Our call for higher bond yields is one important factor behind our
recommendation to underweight bonds in portfolios.
From a technical perspective the outlook for equities remains constructive. The
S&P 500 and S&P/TSX continue to trade in long-term uptrends and above their
40-week moving averages (MA). Market breadth is broadly supportive with the
NYSE Advance/Decline line making new highs, confirming the news highs for US
equities.
In summary, the macro conditions of not too hot, not too cold are very
supportive for equities in that low inflation will allow global central banks to
maintain accommodative policies, while improving economic growth should
result in stronger corporate earnings and in turn, higher stock prices.

3.3

Russell 2000

3.9

MSCI World

5.5

MSCI Europe

18.6

MSCI EAFE

However, we maintain our Moderately Bullish outlook for the equity markets
as we see the potential for further appreciation over the next 6 to 9 months.

Slower economic activity has weighed on corporate earnings with S&P 500
Index (S&P 500) earnings flat over the last two quarters, and S&P/TSX
Composite Index (S&P/TSX) Q1/15 earnings down 35% Y/Y. If the current
economic soft patch proves transitory, as is our expectation, then corporate
earnings growth could pick back up. We continue to forecast mid-single digit
EPS growth for the S&P 500, which we expect to drive mid-single digit returns
for the S&P 500 this year. We expect stronger earnings growth from US and
European stocks relative to Canada, which is one factor in our call to
overweight these regions.

4.8

S&P 500

Our Risk Assessment (see sidebar) of the equity markets has increased slightly
as corporate earnings trends have deteriorated and as we approach the weak
seasonal period for equities (May through October).

The global economy slowed in Q1/15, with global GDP growth of 1.76%, down
from 2.34% in Q4/14. We believe global growth is set to improve in H2/15,
driven by a rebound in the US economy and a continuation of positive
momentum in Europe and Japan.

3.9

9.0

MSCI EM

8.5
-5

Asset Allocation Summary

10

U/W

Neutral

20

O/W

Equities
Fixed Income
Cash
Market Outlook (6 - 9 months)

Risk Assessment

Price Chart
16,000

15,000

2,200
S&P/TSX Comp (LHS)
S&P 500 (RHS)

2,000

14,000

1,800

13,000

1,600

12,000

1,400

11,000

1,200

10,000
May-10 May-11 May-12 May-13 May-14

1,000

Source: Bloomberg, Raymond James Ltd.

Note: U/W = underweight, O/W = overweight

Please read domestic and foreign disclosure/risk information beginning on page 6

Raymond James Ltd. 5300-40 King St W. | Toronto ON Canada M5H 3Y2.
2200-925 West Georgia Street | Vancouver BC Canada V6C 3L2.

15

Asset Allocation

May 26, 2015 | Page 2 of 6

Q1/15 Update
The global economy slowed in Q1/15, with global GDP growth of 1.76%, down from
2.34% in Q4/14. While Europe and Japan experienced an uptick in economic
momentum, China and the US slowed in the quarter. US Q1/15 GDP is currently
estimated at 0.2% annualized, however, we expect this number to be revised lower,
possibly posting a negative print on the back of recent poor trade data. The
slowdown in US economic activity mirrored that of the last few years, where growth
slows in Q1 following a more robust second half. In fact, we have found that since
1985, the US economy has posted a fairly tepid Q1 average growth rate of 1.9%,
roughly 1% below the average Q4 growth rate. We believe global growth is set to
improve in H2/15, driven by a rebound in the US economy and a continuation of
positive momentum in Europe and Japan. We expect China and the emerging
markets to remain under pressure for the remainder of the year. Key supports for
our reacceleration call include:

US turnaround: The US economy was impacted by transitory factors in Q1

with extreme weather, the West Coast port shutdown, a spike in the US
dollar, and lower oil prices weighing on economic activity. As we move into
H2/15 we see some of these factors waning, with activity bouncing back.
Moreover, a strong US labour market should support higher incomes,
consumer spending, and US housing activity. Raymond James Economist,
Scott Brown is forecasting US GDP growth of 2.7% for Q3 and Q4.

Central bank stimulus: While the Fed is on schedule to hikes rates later this
year, many other central banks are diverging with the US by injecting
additional stimulus to their respective economies. For example, the Bank of
Canada, Swiss National Bank and the Peoples Bank of China lowered
interest rates and/or reserve requirements in recent months. Then there is
the European Central Bank and Bank of Japan that are adding massive
amounts of new liquidity/stimulus into their economies through their bond
buying programs. These measures, by lowering interest rates and debasing
their currencies, should help their respective economies.

Lower oil prices: While were calling for higher oil prices in H2/15, we still
expect global oil prices to remain contained, and for West Texas
Intermediate (WTI) to remain below the five-year average of US$90/bbl. We
believe the effects of lower oil prices occur with a lag, and as such, we
expect to see the benefits unfold in the coming months. For example, the
International Monetary Fund estimates that for a 30% drop in oil prices,
world GDP would increase by 0.5%.

Global GDP Softens In Q1/15

ECB Stimulus Provides Tailwind To Economy

4,000

Forecast

ECB Balance Sheet (in bls)

3,500

3
3,000

2
1

2,500

2,000

-1

1,500

-2

1,000

-3
-4

500

World GDP Y/Y

-5
'07

'08

'09

'10

'11

Source: Bloomberg, Raymond James Ltd.

'12

'13

'14

'15

'00

'02

'04

'06

'08

'10

'12

'14

'16

Asset Allocation

May 26, 2015 | Page 3 of 6

Fundamental Update
Slower economic activity has weighed on corporate earnings with S&P 500 earnings
flat over the last two quarters, and S&P/TSX Q1/15 earnings down 35% Y/Y. With
elevated equity valuations, continued weak earnings could leave the equity markets
vulnerable to a correction. However, if the current economic soft patch proves
transitory, as is our expectation, then corporate earnings growth could pick back up.
We continue to forecast mid-single digit EPS growth for the S&P 500, which we
expect to drive mid-single digit returns for the S&P 500 this year. We expect stronger
earnings growth from US and European stocks relative to Canada, which is one factor
in our call to overweight these regions.

US Corporate Earnings
Growth Slowed in H1/15

Recently, global bond yields have surged higher with Germany and US 10-year
government bond yields up 53 and 35 bps, respectively since mid-April. We have
been calling for higher bond yields this year based on our expectations for stronger
global growth and the Fed hiking rates sometime this year. Currently, the
Government of Canada (GoC) 10-year yield sits at 1.78%, up 55 bps from its February
lows. We continue to forecast a year-end value of 2% for the GoC 10-year yield,
which if realized would result in a 5% decline in 2015. Our call for higher bond yields
is one important factor behind our recommendation to underweight bonds in
portfolios.

15%
13%

S&P 500 EPS Growth Rate Y/Y

11%
9%

7.6%

7%

5.2%
2.2%

3%
0.5%

10.3%

6.9%

6.9%

4.3%

5%

1%

12.3%

11.1%

3.8%

1.3%

0.2% 0.6%

-1%

A significant concern some investors have with equities is the prospect of rising
interest rates. Admittedly, a significant tightening of monetary conditions from the
Fed would be worrisome and likely derail the six year bull-run in equities. However,
we believe the Fed will be very slow and gradual in their interest rate hikes, as the
economic recovery remains fragile and inflation remains below their 2% target.
Therefore, we do not see a Fed rate hike later this year derailing the equity bull
market. Moreover, our work suggests that stocks typically do not re-rate until the US
10-year government bond yields rises above 5-6%. Currently, with the 10-year yield
at 2.2%, we are still a long way off from where rising interest rates should lead to a
contraction in P/E multiples.

-1.1%

-3%

Source: Bloomberg, Raymond James Ltd.

Given the combination of improving corporate earnings growth and rising bond
yields in H2/15, we maintain our overweight recommendation in equities.

P/Es Typically Contract When Yields Rise Above 5-6%

Global Bond Yields On The Rise

3.00

25

S&P 500 Median P/E

2.50
2.00

1.50
1.00

0.50
0.00
Jan-14

Jul-14

Source: Bloomberg, Raymond James Ltd.

20
15

17.3

19.2

18

14.9

13.8

14
12.2
9.6

10
5

10-Year US Treasury Yield %

10-Year GoC Yield %
10-Year Germany Yield %

Apr-14

22.9

0
Oct-14

Jan-15

Apr-15

<3%

3-4%

4-5%

5-6%

6-7%

7-8%

10-Year Gov't Bond Yield Ranges

8-9%

9-10%

<10%

Asset Allocation

May 26, 2015 | Page 4 of 6

Technical Update
From a technical perspective the outlook for equities remains constructive. The S&P
500 and S&P/TSX continue to trade in long-term uptrends and above their 40-week
moving averages (MA). Market breadth is broadly supportive with the NYSE
Advance/Decline line making new highs, confirming the news highs for US equities.
In the near-term we have two key concerns that we are closely monitoring. First, is
weak seasonality, with May through October being the weakest period for equities.
We expect volatility to pick up in the coming spring/summer months and see the
potential for a pullback over this period. However, we expect any short-term
weakness to be modest, and therefore we are not adjusting our overweight equity
allocations. The second market trend that we are monitoring is the recent
divergence between the Dow Jones Industrials and Transports, with the Transports
significantly lagging the Industrials. According to Dow Theory, the Transports need to
confirm the Industrials, and when they begin to diverge and underperform, it can
provide an early warning signal for the equity markets. At present, we only have a
divergence rather than a sell signal so while it requires close monitoring, the
preponderance of technical readings remain bullish, in our view.
Conclusion
In summary, we continue to recommend an overweight in equities and underweight
in cash and bonds. The macro conditions of not too hot, not too cold are very
supportive for equities in that low inflation readings allow global central banks to
maintain accommodative policies, while improving economic growth should result in
stronger corporate earnings and in turn, higher stock prices.

S&P 500 Remains In Long-term Uptrend

Seasonality Is Negative Through The Summer

2.5%

2,100

2.1%

2.0%

1,900

1.7%

1.5%

1,700

1.0%

1,500

1.0%
0.6%

0.5%

0.5%

1,300

0.0%

1,100

-0.5%

0.7%

-0.2%
-0.7%

-1.0%

900

-1.5%

S&P 500
40-Week MA

700
'06

'07

'08

-1.4%

-2.0%

500
'05

0.7% 0.6%

0.7%

'09

'10

Source: Bloomberg, Raymond James Ltd.

'11

'12

'13

'14

'15

S&P/TSX Composite Seasonality (1990 to present)

-2.5%
Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Asset Allocation

May 26, 2015 | Page 5 of 6

Asset Class Weightings

Profile
Income & Capital Preservation
Conservative
Moderate
Growth
Global Equity
General Asset Class Ranges

Cash
40%
15%
5%
0%
0%
Cash
40 75
15 30
5 10
05
0

Income & Capital Preservation

Conservative
Moderate
Growth
Global Equity
Profile Descriptions
Income & Capital
Preservation
Conservative
Moderate
Growth

Global Equity
Income & Capital
Preservation

Bond
40%
65%
47%
20%
0%

Bonds
15 40
60 65
45 65
15 40
0

US Equity
0%
0%
20%
35%
40%

Equities
0 20
10 20
25 45
50 70
80 85

Alt Cash
3% 5%

US
Equity
20%

Cash
15%
Can
Equity
20%

Bonds
40%

Intl. Equity
0%
0%
15%
20%
25%

Alternative
0%
0%
3%
10%
15%
Alternative
0
0
05
10 15
15 20

Description
Virtually any loss is unacceptable. Investors primary objective is to achieve a return that keeps pace with
inflation. Fixed income and cash make up the largest portion of holdings.
Losses can be tolerated, but erosion of regular income payments cannot. Stability of coupon or dividend is the
primary concern as many investors will employ this income for cost-of-living expenses. Bonds tend to make up
the largest proportion of holdings.
Some higher risk positions tolerated but these are typically offset with blue-chip dividend paying equities or lowrisk bonds.
Willingness to take speculative bond and equity positions though growth portfolios are typically biased towards
equities. Strong earnings growth or high yields usually take preference over valuations. Some defensive
constraints may be employed, but even these may be removed for highly risk-tolerant investors.
A willingness to ignore home-country bias and allocate holdings internationally. International equities typically
receive weightings equivalent to or greater than domestic securities. These investors recognize that Canada
represents only ~3% of global equity markets and are willing to source investment opportunities outside our
borders.
Conservative
Moderate
Growth
Global Equity

Cash
40%

Can
Equity
20%

Can. Equity
20%
20%
10%
15%
20%

Intl
Equity
15%
Bonds
65%

US
Equity
35%
Alt
10%

Can
Equity
10%

Bonds
47%

Intl
Equity
20%
Can
Equity
15%

Bonds
20%

US
Equity
40%

Intl
Equity
25%

Alt
15%

Can
Equity
20%

Asset Allocation

May 26, 2015 | Page 6 of 6

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product of the Research Department of RJL.
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be based on technical analysis and may or may not take into account information contained in fundamental research reports published by RJL or its
affiliates. Information is from sources believed to be reliable but accuracy cannot be guaranteed. It is for informational purposes only. It is not
meant to provide legal or tax advice; as each situation is different, individuals should seek advice based on their circumstances. Nor is it an offer to
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