GLOBAL INVESTMENT COMMITTEE

AUG. 17, 2015

The GIC Weekly

What We Are Talking About

LISA SHALETT
Head of Investment & Portfolio Strategies
Morgan Stanley Wealth Management
Lisa.Shalett@morganstanley.com
+1 212 296-0335

For additional insight into market

performance, sentiment, macroeconomic trends and the GICs
latest thinking, please see the new
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Upcoming Catalysts
Aug. 17 Empire State Manufacturing Survey
Aug. 17 NAHB/Wells Fargo Housing Market Index
Aug. 17 Euro Zone trade balance
Aug. 18 US housing starts
Aug. 18 Japan trade balance
Aug. 19 US Consumer Price Index
Aug. 19 FOMC July meeting minutes
Aug. 20 US existing home sales
Aug. 20 Philadelphia Fed Survey
Aug. 20 US leading indicators
Aug. 21 Euro Zone consumer confidence

Chinas New Currency Policy: No Black Swan

Devaluation of the renminbi no surprise, but timing was;
fears that it will exacerbate global deflationary pressures
likely to be short-lived; currency markets are a zero-sum
game, not driving global growth but redistributing its
spoils; renminbis move toward a market-based exchange
rate instead of a US-dollar peg should help stabilize
Chinas growth and propel market reforms; Chinas action
means global monetary policy is even more stimulative
and could keep Fed rate hike on hold until December.
Consider adding potential beneficiaries such as retailers
and housing-related stocks while reducing possible
victims like technology companies. Review cheap
cyclicals like industrials, which could ultimately benefit
from Chinas recovery. Continue to add China H-shares.
Chinas New Currency Policy: No Black Swan
When Chinese authorities announced on Aug. 11 that they would allow their currency,
the renminbi, to move toward a market-based exchange rate and abandon its peg to the US
dollar, global markets reacted violently. They treated it like a black swana hard-topredict, rare event that is beyond the realm of normal expectations. But while the timing
was a surprise, the move, which resulted in a 3% devaluation by the end of the week, was
in the making. China had been expected to wait until the September International
Monetary Fund (IMF) meeting to reconsider the peg, which had been in effect since 2008
and had provided stability in the increasingly volatile currency market.
Fears multiplied that Chinas move signaled economic weakness and recent deterioration in export growth, down a year-over-year 8% in July, underscored the problem. The
decline in the renminbi versus the US dollar was viewed by many as yet another global
growth scare that would intensify global deflationary pressures and trigger currency wars.
Stocks of exporters who cater to Chinese consumers were punished on the belief that the
weaker currency would make imports, especially luxury goods, more expensive. Chinas
action also roiled commodities and emerging market equities, where investors opined that

Please refer to important information, disclosures and qualifications at the end of this material.

THE GIC WEEKLY

the move would exacerbate the dollars strength, putting more

downward pressure on those asset classes. Credit markets
suffered, too, over concerns that Chinese borrowers exposed to
US-dollar debt would be squeezed, too.
Although the Global Investment Committee (GIC) acknowledges that some of these concerns have validity, we do not
believe that Chinas move toward a floating exchange rate is
bad for global growth or economic policy. In fact, there is a
solid economic rationale for it. Remember that currency markets
are a zero-sum game. As one currency goes up, others go down.
Free-floating currencies are mere reflections of global monetary
flows, relative interest rate policy and relative purchasing power,
or inflation. When one countrys currency is pegged to that of
another, as the renminbi was to the dollar, the country has few
policy tools with which to manage its economy.
With the Peoples Bank of China embarking on monetary
stimulus while the Federal Reserve is poised to hike interest
rates, policymakers needed to rethink the peg. Specifically, with
the 25% appreciation of the US dollar versus major trading
partners during the past year, the renminbi has also strongly
appreciated, creating stiff headwinds for a slowing economy.
Based on Chinas trade-weighted basket of currencies, the
renminbis real effective exchange rate as of the end of June was
up 14% in the past year (see Chart of the Week, page 3). In
essence, Chinas monetary policy was artificially tight. That
inhibited export competitiveness and exacerbated deflationary
forces. In July, Chinas Producer Price Index was -5.4%, the
worst in 41 months of decline. Such a loss of pricing power can
put even more downward pressure on commodities as inventory
stockpiles are liquidated. Thus, it is possible that the weaker
currency slows deflation inside China. Another concern has
been that this counters Chinas goal of moving toward
consumption and away from manufacturing, since a weaker
currency tends to spur export growth. We think such thinking is
simplistic and conflates the mix of economic growth with its
sources. Chinas consumption and its service sector can
continue to grow, whether growth is sourced internally or from
imports. Finally, when exchange rates are set by policy instead
of by markets they can become distorted, which can lead to
capital misallocation. With China already suffering the weight
of excess manufacturing capacity, an overly strong currency
may have been keeping unproductive assets in place. To the
extent that currency repricing better reflects genuine economic
returns, global growth can more quickly rebalance and improve.
All told, we dont think this will result in major shifts in
economic growth. Assuming that the renminbi trades toward
purchasing power parity estimates of fair value in the next year,

it may depreciate another 3% to 5%. Furthermore, some

commentators say this policy change will further strengthen the
US dollar. We are not convinced. If Beijings policy is based on
Chinas trade-weighted basket of currencies, then currency
market rebalancing against the renminbi gets distributed against
the currencies of all the major trading partners, including the
euro and the yen. Under that scenario the US dollar stabilizes
and along with it, commodities which are priced in dollars.
Indeed, since Chinas action,the US dollar has retreated.
The new currency policy is also integral to Chinas reform
agenda, which includes the internationalization of the renminbi
and gaining its acceptance as an IMF Strategic Drawing Rights
(SDR) currency. IMF reports show that the SDR review was
pushed back to November from September because of turmoil in
Chinas equity markets and because officials wanted China to
move toward market-based exchange rates. From this point, last
weeks move shows that China is not only committed to such
reforms but that it can manage them. Demonstrating such
control will also help re-establish credibility with many Chinese
investors whose confidence has been shaken by the equity
market selloff. Finally, with China President Xi Jinping
planning to visit President Obama next month, we doubt that the
currency move is part of a blatant mercantilist strategy.
Despite the wisdom of the change, there are further
implications worth noting. Indeed, in the short term, Chinas
trading partners in Asia may feel pressured to further cut rates,
potentially accelerating the depreciation of their currencies and
in turn putting downward pressure on their stock markets.
Emerging markets with capital outflows could face problems
servicing their US-dollar debt, which is similar to what
happened in the 1997-1998 Asian currency crisis. Companies
that compete directly with Chinese manufacturers may lose
market share and firms that export to Chinese consumers may
face headwinds. And if the changes cause the US dollar to
appreciate further, the Fed may hold off on its rate hike until
December or even early 2016, while lower-for-longer energy
and commodity prices support global consumption and better
margins for companies that use commodities as inputs.
Bottom Line: Chinas new currency policy is about
rebalancing, which in the intermediate to long term is
stimulative because it should leads to better capital allocation.
Watch for the US dollar and commodities to stabilize.
Consider adding to potential beneficiaries of the weak renminbi,
such as US retailers and housing-related stocks. Reduce
exposure to technology, which could be hurt by the devaluation.
Begin reviewing cheap industrials that could benefit from
Chinas eventual recovery. Continue to add China H-shares.

Please refer to important information, disclosures and qualifications at the end of this material.

Aug. 17, 2015 2

THE GIC WEEKLY

Chart of the Week: China vs. the USWhos Currency Is the Bigger Headwind?
Markets were roiled last week by China's decision to remove the
renminbis peg to the US dollar and move toward a marketbased exchange rate. While some have suggested that China's
move was a capitulation to weak growth and slowing exports, the
GIC believes it is more foundational. Dropping the dollar peg
was prudent given the expected Fed rate hike, which would be
divergent from Chinas monetary policy aims. Besides supporting
China's commitment to gaining Strategic Drawing Rights for the
renminbi, it was also an economic necessity. While the
strengthening of the dollar has been roughly 25% in nominal
terms, in real terms it has been more modest. But for China,
which had domestic deflation at the same time, the real effective
trade-weighted exchange rate for the renminbi was up in excess
of 14%, nearly twice the real impact on the dollar since 2011.

150
Real Effective Trade-Weighted Exchange Rate
140
+33%
Renminbi US Dollar
130
120
+10%
110
100
90
80
70
60
50
1994 1997 2000 2003 2006 2009 2012 2015

Source: Haver Analytics as of June 30, 2015

Asset Class Performance and Heat Map (as of Aug. 14, 2015)
Asset Class
Cash
90-Day US Treasury Bills

Annualized Returns (%)

Yield

YTD

1-Yr.

2014

3-Yr.* 5-Yr.* 10-Yr.* 20-Yr.*

0.0

0.0

0.0

0.0

0.1

1.3

2.6

7.1
-0.5
5.4
0.9
5.7
-0.1
5.5
13.9
-5.6
-7.9

15.8
4.3
11.5
6.7
11.2
4.2
-0.8
10.1
-14.2
-17.1

15.0
12.2
11.9
13.2
5.5
9.7
-5.7
-3.7
-0.3
-1.8

20.2
15.9
19.8
19.5
20.4
17.2
14.2
13.7
7.2
1.6

20.2
15.7
19.4
17.4
19.6
16.6
11.4
9.1
8.6
2.6

9.6
6.8
9.4
8.6
10.9
8.9
6.0
4.4
8.2
7.7

8.5
8.7
8.9
10.9
10.6
11.1
7.8
1.2
6.9
6.0

1.0
0.5
0.6
-2.8
2.1
2.8

1.1
2.1
3.8
-6.4
-0.5
5.3

1.4
6.0
8.4
3.5
2.6
8.2

1.3
2.1
4.5
0.6
7.5
5.9

1.9
3.5
4.1
4.2
8.8
7.5

3.4
4.5
4.2
4.7
8.4
8.4

4.6
5.7
6.1
7.0
8.8
10.1

0.8
-17.5
-14.9
-5.7
2.7
-3.2
2.9
1.4
6.0
2.5

2.3
-25.7
-30.4
-18.0
5.0
15.0
9.7
7.6
-0.1
2.1

14.7
4.8
-18.7
-6.7
3.4
12.4
13.7
4.9
-4.5
4.7

9.9
6.6
-12.0
-14.4
6.4
2.0
18.1
17.4
13.2
14.0

12.1
10.8
-6.7
-3.5
4.2
2.1
17.8
16.8
10.5
12.7

6.4
11.0
-5.2
8.5
3.2
3.6
8.1
8.3
5.8
7.1

9.0
1.7
5.5
5.8
5.6
9.0
9.1
5.7
7.2

Global Equities
US Large-Cap Growth
US Large-Cap Value
US Mid-Cap Growth
US Mid-Cap Value
US Small-Cap Growth
US Small-Cap Value
Europe Equity
Japan Equity
Asia Pacific ex Japan Equity
Emerging Markets*****
Global Fixed Income
Short-Term Fixed Income
US Fixed Income
International Fixed Income
Inflation-Linked Securities
High Yield
Emerging Markets Fixed. Inc.
Alternative Investments
REITs
Master Limited Partnerships***
Commodities ex Prec. Metals
Precious Metals
Hedged Strategies*
Managed Futures****
S&P 500
Russell 2000
MSCI EAFE
MSCI AC World

Current
YTM
0.06
Current
Div. Yld.
1.22
2.97
0.84
2.61
0.62
2.57
3.06
1.71
3.95
2.68
Current
YTM
1.37
2.42
1.30
7.16
6.81
Current
Div. Yld.
3.51
1.95
1.34
2.93
2.44

*July 31, 2015 **20-year average as of July 31, 2015. ***Volatility and Correlation: June 30, 2006 Present. Hedged strategies consist of hedge funds and managed futures. ****Returns as of June 30,
2015. *****Values calculated using USD
Source: FactSet, Bloomberg

Valuation

Volatility (%)

Correlation to
Global Equities

Current
Avg.
30 Days 20 Yrs.* 30 Days 20 Yrs.*
YTM
YTM
0.06
1.42
0.00
0.64
0.12
-0.01
Current
Avg.
P/E*
P/E**
20.4
17.9
11.1
17.9
0.85
0.89
15.9
12.9
9.9
14.4
0.86
0.88
24.5
20.3
11.5
23.5
0.88
0.80
16.5
14.1
10.6
16.3
0.81
0.87
28.7
22.2
12.3
22.6
0.85
0.82
20.0
17.4
10.5
17.1
0.83
0.84
15.3
13.3
12.0
18.0
0.87
0.94
15.5
17.2
10.1
18.0
0.27
0.67
14.7
14.2
14.3
21.4
0.67
0.85
11.1
10.6
13.2
23.5
0.77
0.85
Current
Avg.
Spread Spread**
33.0
30.0
1.5
2.1
-0.44
-0.08
59.0
54.0
3.1
3.5
-0.50
-0.01
50.0
52.0
2.3
2.6
-0.51
-0.07
5.9
7.4
-0.28
0.43
542.0
490.0
2.6
9.6
0.73
0.74
356.0
304.0
1.5
9.7
0.34
0.47

16.4
23.6
15.3
15.5

14.9
20.5
13.9
14.1

6.4
31.8
16.1
12.8
10.04
11.88
10.15
9.02

18.3
15.6
16.8
18.9
15.1
19.8
16.6
15.6

0.47
0.18
0.69
0.10
0.89
0.82
0.84
1.00

0.79
0.40
0.44
0.21
0.69
-0.08
0.95
0.81
0.96
1.00

Cheap

Low

Low

Moderate

High

High

Expensive

Please refer to important information, disclosures and qualifications at the end of this material.

Aug. 17, 2015 3

THE GIC WEEKLY

Morgan Stanley & Co. Forecasts (as of Aug. 14, 2015)

Global
US
Euro Zone
UK
Japan
Emerging Markets
China

10-Yr. Govt.
Bond Yield (%)
2016E Q4 15E Q2 16E
3.9
2.7
2.6
2.9
2.2
1.9
2.5
2.8
1.9
0.8
1.3
5.1
7.0
3.3
3.2

Real GDP Growth (%)

Headline Inflation (%)

2014
3.4
2.4
0.9
3.0
0.0
4.8
7.4

2014
3.5
1.6
0.4
1.5
2.6
5.1
2.0

2015E
3.4
2.5
1.4
2.7
1.0
4.4
7.0

2015E
3.1
0.1
0.2
0.2
0.6
5.3
1.3

2016E
3.4
1.8
1.6
1.5
1.3
4.7
1.8

Currency Versus US Dollar

Q3 15E

Q4 15E Q3 16E

1.08
1.58
122

1.05
1.54
121

0.97
1.49
124

N/A

N/A

N/A

Source: Morgan Stanley & Co. Research

Macro Factor Heat Map (as of Aug. 14, 2015)

Economic
Growth

Rates

Inflation /
Deflation

Liquidity

Sentiment and
Risk

Valuation

Earnings

GIC Conclusion

-1

Range Bound,
0 for
Looking
Catalysts

US

Bearish Sentiment

Japan

-1

Encouraging
1
Momentum

Europe

-1

Positive
1
Catalysts
Evident

China

-1

Non0
Consensus
Bulls

Brazil

-1

-1

-1

-1

Stagflation;
-1
Avoid

Curve Flatter

Risk Asset
Positive

Neutral

Risk Asset
Negative

Note: Text in a factor box denotes a color change; Brazil rates went from risk asset positive to neutral as the curve flattened; US sentiment went from
neutral to risk asset positive as sentiment was more bearish; For a further explanation of the chart, see page 8.
Source: Morgan Stanley Wealth Management GIC

Market Factor Data Points (for the week ending Aug. 14, 2015)
Positives

July US retail sales up 0.4% ex autos with positive

revisions; improves third-quarter GDP outlook
US industrial production improved strongly, up 0.6%
month over month in July versus 0.3% estimate
US productivity rebounded in second quarter
JOLTS job openings fell in June after Mays record high
July rebound for NFIB small business sentiment

July US PPI above expectations

Chinas CPI ticked up in July

Global Growth

Inflation

Greece reached accord with creditors for its third

bailout
Source: Morgan Stanley Wealth Management GIC

Sentiment and Flows

Negatives

US business inventories increased more than expected

in June
Euro Zone second-quarter GDP slightly light at 1.3%
annual rate; year-over-year change is 1.6%
China exports fell in July, while imports fell for ninth
month in a row
Chinas industrial production slowed in July
China allows devaluation of the renminbi
China PPI dropped in July amid weak demand
OPEC output at three-year high; oil prices at six-year
low
Global markets rocked by China devaluation
German investor confidence dropped in August

Please refer to important information, disclosures and qualifications at the end of this material.

Aug. 17, 2015 4

THE GIC WEEKLY

S&P 500 Earnings Estimates

Consensus
Morgan Stanley

MS & Co. S&P 500 12-Month Price Target

EPS Landscape

Scenario
Probability

2015E

2016E

P/E
Ratio

Scenario
Target

Upside /
Downside

Bull Case

20%

132.1

141.3

18.1

2,600

24.3%

11%

7%

124.0

131.0

17.2

2,275

8.7%

4%

6%

111.9

106.3

16.0

1,700

-18.7%

-6%

-5%

$132 $131
$124
$119

$119

Growth
Base Case

60%

Growth
Bear Case

20%

Growth
2014

2016E

2015E

Current S&P 500 Price

2,092

Source: FactSet, Thomson Reuters, Morgan Stanley & Source: Thomson Reuters, Morgan Stanley & Co. Research as of Aug.14, 2015
Co. Research as of Aug. 14, 2015

S&P 500 Sector Performance and Valuation (as of Aug. 14, 2015)
Total Return
WTD (%) YTD (%) 1-Year (%) Dividend Yield (%)

Index Name

Beta

Forward 12-Mo. P/E*

S&P 500
0.73
2.88
9.18
1.95
Energy
3.50
-12.07
-25.25
3.29
1.15
Materials
1.14
-5.02
-6.47
2.24
1.11
Industrials
1.29
-2.58
4.80
2.14
1.07
Consumer Discretionary
0.12
9.40
18.43
1.32
0.96
Consumer Staples
0.05
4.55
15.52
2.49
0.71
Health Care
0.09
10.90
23.52
1.43
1.04
Financials
0.32
3.05
13.35
1.78
1.01
Information Technology
0.68
3.44
11.14
1.47
1.10
Telecommunication Services
0.99
2.85
0.04
4.60
0.67
Utilities
2.66
-1.79
12.97
3.57
0.65
*Dark blue/light blue/gray fill denotes whether current relative forward 12-month P/E is low/neutral/high relative to history.
Source: Morgan Stanley & Co.

16.4
23.4
15.3
15.8
19.0
19.7
17.3
13.4
15.8
12.5
16.3

Performance of Style and Cap Pairs (as of Aug. 14, 2015)

1.06
Small Cap vs. Large Cap
1.04
1.02
1.00
0.98
0.96
0.94
0.92
0.90
0.88
Aug '13
Dec '13
Apr '14
1.18
1.12

Aug '14

Dec '14

Apr '15

Aug '15

Cyclicals vs. Defensives

1.06
1.00
0.94
0.88
0.82
0.76
0.70
Aug '13

Dec '13

Apr '14

Aug '14

Dec '14

Apr '15

Aug '15

1.13
1.12 Growth vs. Value
1.10
1.09
1.07
1.06
1.04
1.03
1.01
1.00
0.98
Aug '13
Dec '13
Apr '14

Aug '14

Dec '14

Apr '15

1.08
Quality vs. Junk
1.07
1.05
1.04
1.02
1.01
0.99
0.98
0.96
0.95
0.93
Aug '13
Dec '13
Apr '14

Aug '14

Dec '14

Apr '15

Aug '15

Aug '15

Source: Morgan Stanley & Co. Small Cap is represented by the Russell 2000 Index; Large Cap represented by the Russell 1000 Index; Growth
represented by the Russell 1000 Growth Index; Value represented by the Russell 1000 Value Index.Cyclicals, Defensives. Quality and Junk are
based on Morgan Stanley & Co. Research analysis.

Please refer to important information, disclosures and qualifications at the end of this material.

Aug. 17, 2015 5

THE GIC WEEKLY

Fixed Income Weekly Insight: Tax-Exempt Muni Yield Climbs Above Taxable Treasury Yield
This weeks chart shows the 10-year relative-value
ratio, which captures the percentage yield of 10-year
AAA municipal bond yields relative to 10-year US
Treasuries. While the ratios long-term average is
83%, the current relative-value ratio is 102%. That
means tax-exempt munis are yielding more than
taxable Treasuries, a level that is usually attractive
for muni investors. The ratios latest move above
100% is due to a flattening of the Treasury yield
curve in which longer-term yields declined. Since
muni yields often follow Treasuries with a lag, we
would expect the relative-value ratio to come down,
too.

110 %
10-Year Relative-Value Ratio*

105
100
95
90
85
80

Jul '14

Oct '14

Jan '15

Apr '15

Jul '15

*Yield on 10-year AAA municipal relative to yield on 10-year US Treasury

Source: Bloomberg as of Aug. 14, 2015

Government Debt Monitor (as of Aug. 14, 2015)

US
Yield (%)
Current WTD

Global
Yield (%)

Total Return (%)

YTD

YTD

10-Year Govt. Bond Current WTD

3-Month
2-Year
5-Year
10-Year
30-Year

0.09
0.71
1.57
2.19
2.86

0.03
-0.01
0.00
0.02
0.04

0.05
0.04
-0.08
0.01
0.10

0.01
0.58
1.48
0.98
-0.93

France
Germany
Japan
Spain
UK

2-Yr./10-Yr. Spread (bp)

10-Yr. TIPS Breakeven (bp)

148
163

3.27
-3.58

-2.86
-5.45

Treasury Benchmark

0.95
0.63
0.37
1.95
1.84

Total Return (%)*

YTD

YTD

0.13
0.09
0.05
0.35
0.08

0.19
0.41
0.33
-1.02
-0.38

-0.02
-0.03
-0.04
-0.03
-0.01

0.32
0.01
0.06
US Tax Exempt
10-Year AAA Muni
2.20
-0.01
-0.57
0.94
Interest Rate Volatility** (bp) 80
3.77
11.06
10-Yr. Muni/UST Ratio 100.30 -1.50
8.27
*Global total returns reflect Citigroup 7- to 10-year bond indexes and Muni total returns reflect Barclays Municipal Bond Index Total Return
**Interest Rate Volatility measured by Merrill Lynch Option Volatility Estimate (MOVE) Index
Source: Bloomberg, Thomson Reuters Municipal Market Data (MMD)

Fixed Income Spread Dashboard

Benchmark Returns

OAS Range**
Duration Yield-to- OAS
Past Two Years (bp)
(Yrs.) Worst (%) (bp)
Rich
Cheap

High Yield Investment Grade

3-Month LIBOR

Total Returns (%)

Index

YTD

MTD

2014

MBS*

4.09

2.51

22

-3

55

Barclays Aggregate

0.55

-0.04

5.97

AAA

4.14

1.48

22

34

Barclays US MBS

0.87

-0.07

6.08

AA

5.02

1.91

14

26

Barclays Municipal

0.94

0.10

9.05

6.79

2.97

125

79

125

Investment Grade

-0.60

-0.38

7.48

BBB

7.34

4.07

220

134

220

High Yield

0.18

-1.51

1.83

BB

4.67

5.77

424

253

451

World Government Bonds (FX)

0.77

0.12

8.47

4.08

7.57

619

367

641

Emerging Markets US$

1.09

-0.55

6.95

CCC

3.51

11.42

1,100

664

1,125

Unless stated, indexes utilized are Citi Broad Investment Grade, Citi High Yield, and Citi Global Indexes.
*MBS distills high grade agency-rated mortgage-backed securities, a substantial subsector of investment grade indexes
**OAS stands for Option-Adjusted Spread or spread over the Treasury. Grey diamond denotes current OAS; blue circle denotes two-year average.
Source: Bloomberg, The Yield Book Software and Services. 2015 Citigroup Index LLC. All rights reserved. Data as of August 14, 2015

Please refer to important information, disclosures and qualifications at the end of this material.

Aug. 17, 2015 6

THE GIC WEEKLY

Tactical Asset Allocation Reasoning

Global Equities

Relative Weight
Within Equities

US

Overweight

While US equities have done exceptionally well since the global financial crisis, they still offer attractive upside potential,
particularly relative to bonds. We believe the US and global economies continue to heal, making recession neither
imminent nor likely in 2015 or 2016. This is constructive for global equities, including the US.

International Equities
(Developed Markets)

Overweight

We maintain a positive bias for Japanese and European equity markets given the political and structural changes taking
place in Japan and our expectation for an improving economic outlook in Europe. European and Japanese central
banks are now engaged in much more aggressive monetary policy than the US, while also moving away from fiscal
austerity. This should be relatively more stimulative for growth on a rate-of-change basis and lead to continued
outperformance in these equity markets.

Emerging Markets

Overweight

Emerging market (EM) equities have been a mixed bag for the past few years and we expect that to continue. While the
broad emerging market equity asset class remains vulnerable to Federal Reserve Bank tightening and US dollar
strength, emerging market equities should perform better with a more synchronous global economic recovery and more
aggressive central-bank activity outside the US. We think recommend a selective approach, focusing on India, China Hshares, Taiwan and Korea.

Global Fixed
Income

Relative Weight
Within Fixed
Income

US Investment Grade

Underweight

We have recommended shorter-duration* (maturities) since March 2013 given the extremely low yields and potential
capital losses associated with rising interest rates from such low levels. We have subsequently reduced the size of our
overweight in short duration with short-term interest rates now expected to move higher with the Feds tightening cycle
later this year. Within investment grade, we prefer BBB-rated corporates and A-rated municipals over US Treasuries.

International
Investment Grade

Underweight

Yields are extremely low globally, leaving very little value in international fixed income, particularly as the global
economy begins to recover more broadly. While interest rates are likely to stay low, the offsetting diversification benefits
do not warrant much, if any, position, in our view.

Inflation-Protected
Securities

Overweight

We had been underweight inflation-protected securities since March 2013 given negative real yields across all
maturities. However, with deflationary fears having become extreme in the first quarter of 2015, we believe these
securities now offer relative value in the context of our forecasted acceleration in global growth and rise in oil prices.

High Yield

Overweight

The sharp decline in oil prices has created some dislocations in the US high yield market. Broadly speaking, we believe
default rates are likely to remain muted as the economy recovers, while corporate and consumer behavior remain
conservative. We prefer higher-quality (B to BB) issues and vigilance on security selection at this stage of the credit
cycle. With energy-related issues, investors should remain selective.

Underweight

We remain underweight as the Feds rate-hike cycle will likely be a disproportionate headwind for emerging market
(EM) debt. Much like EM equities, EM debt exposure should be selective. For investors who want to own EM debt, the
GIC recommends US-dollar-denominated debt with a focus on China, India and Mexico.

Emerging Market
Bonds

Alternative
Investments
REITs

Commodities

Relative Weight
Within Alternative
Investments
Underweight

Overweight

With our expectation for rising interest rates, we believe REITs are now fairly to slightly overvalued, especially relative to
other high-yielding asset categories. Therefore, we recently reduced our tactical asset allocation. Non-US REITs
should be favored relative to domestic REITs at this point.
Most commodities have underperformed in the past few years, with energy leading the charge lower. We believe
commodities are likely to perform better for the remainder of 2015 as global growth reaccelerates and the oil market
comes into better supply/demand balance.

Master Limited
Partnerships*

Equal Weight

Master limited partnerships (MLPs) should do better in 2015 if oil prices recover as we expect. With interest rates still
low and average yields on MLPs close to 6%, significant relative value has been created in this asset category. We
continue to favor midstream assets.

Hedged Strategies
(Hedge Funds and
Managed Futures)

Equal Weight

This asset category can provide uncorrelated exposure to traditional risk-asset markets. It tends to outperform when
traditional asset categories are challenged by growth scares and/or interest rate volatility spikes. Within this asset
category, we favor event-driven strategies, given our expectation for increased mergers-and-acquisitions activity.

*For more about the risks to Master Limited Partnerships (MLPs) and Duration, please see the Risk Considerations section beginning on
page 10 of this report.
Source: Morgan Stanley Wealth Management Global Investment Committee as of Aug. 14, 2015

Please refer to important information, disclosures and qualifications at the end of this material.

Aug. 17, 2015 7

THE GIC WEEKLY

Macro Factor Heat Map Key (see page 4)

Economic
Growth

Rates

Inflation /
Deflation

Liquidity

Sentiment and Risk

Valuation

Earnings Conclusion

Dark Blue Economic growth

robust

Steep yield curve

Low-moderate and Liquidity robust Shorter-term sentiment and

rising inflation
in economy / technicals bearish
banking
system

Risk assets
attractively
valued

Earnings
outlook
robust

Confluence of factors
supports a risk-on
investment approach

Light Blue Economic growth

neutral

Normal yield curve

Low-moderate and
declining inflation;
moderate inflation;
higher and falling
inflation

Liquidity
neutral in the
economy /
banking
system

Risk assets
neutral

Earnings
outlook
neutral

Confluence of factors
supports a neutral
investment approach

Gray

Economic growth
anemic

Flat/inverted yield
curve

Very high/low
inflation/deflation;
high and rising
inflation

Liquidity low in Shorter-term sentiment and

economy /
technicals bullish
banking
system

Risk assets are Earnings

richly valued
outlook
anemic

Confluence of factors
supports a risk-off
investment approach

Up

Growth accelerating Yield curve

steepening

Inflation rising

Liquidity
increasing

Sentiment becoming more

bullish

Valuations rising Earnings

outlook
improving

Down

Growth declining

Yield curve flattening Inflation falling

Liquidity
decreasing

Sentiment becoming more

bearish

Valuations falling Earnings

outlook
worsening

Signal
Hor
izon

One to three years

One to three years

One to three months

Six months to
two years

Inputs

Industrial prod 10-year vs. 2-year Consumer Price

uction
government bond
Index
Unemployment
yield spread
Total return
Earnings revisions
Home prices
OECD LEI (China
and Brazil)
MS & Co. ARIA
(US)

One to three years One to three

years
M1 growth
Private credit
growth
Libor-OIS
spread

Shorter-term sentiment and

technicals neutral

MS US Equity Risk Indicator Forward

(US)
price/earnings
MS Combined Market
ratio
Timing Indicator (Europe)
Price/book
MS Global Risk Demand
ratio
Index
Equity risk
Relative strength index
premium
Members above / below
High yield
moving average.
option-adjusted
Index above / below moving spread
average
Consumer confidence

Please refer to important information, disclosures and qualifications at the end of this material.

Six months
to two
years
Earnings Weighted average
revisions z-score of all factors
breadth
Earnings
surprise
Return
on equity

Aug. 17, 2015 8

THE GIC WEEKLY

Index and Survey Definitions

BARCLAYS MUNICIPAL BOND INDEX This is
a rules-based, market-value-weighted index
engineered for the long-term tax-exempt
bond market.

CITI JAPAN GBI CURRENCY HEDGED 7 TO

10 YEAR USD This index measures the

seven risky assets versus their safer

counterparts; plus, three volatility indicators.

performance of Japan sovereign bonds in

the seven-to-10-year maturity range and is
denominated in US dollars.

MSCI ALL COUNTRY WORLD INDEX This is

BARCLAYS US AGGREGATE BOND INDEX

This index tracks US-dollar-denominated

investment grade fixed rate bonds. These
include US Treasuries, US-governmentrelated, securitized and corporate securities.
BARCLAYS US CORPORATE HIGH-YIELD
INDEX This index measures the market of

US-dollar-denominated, noninvestment
grade, fixed-rate, taxable corporate bonds.
BARCLAYS US MORTGAGE-BACKED
SECURITIES INDEX This is an index which

CITI SPAIN GBI CURRENCY HEDGED 7 TO 10

YEAR USD This index measures the

performance of Spain sovereign bonds in

the seven-to-10-year maturity range and is
denominated in US dollars.
CITI UK GBI CURRENCY HEDGED 7 TO 10
YEAR USD This index measures the

performance of UK sovereign bonds in the

seven- to-10-year maturity range and is
denominated in US dollars.

covers the mortgage-backed securities

component of the Barclays US Aggregate
Bond Index.

CITI US BIG CORPORATE BOND INDEX This

CITI EMERGING MARKET SOVEREIGN BOND

INDEX This index includes Brady bonds and

CONSUMER PRICE INDEX This index

US-dollar-denominated emerging markets

sovereign debt issued in the global, Yankee
and Eurodollar markets, excluding loans. It
comprises debt in Africa, Asia, Europe and
Latin America.
CITI EURO BROAD INVESTMENT GRADE
BOND (EUROBIG) INDEX This is a

comprehensive representation of the

European investment grade corporate bond
market.
CITI HIGH YIELD MARKET INDEX This

index
tracks performance of below-investment grade debt issued by corporations domiciled
in the US and Canada.

CITI FRANCE GBI CURRENCY HEDGED 7 TO

10 YEAR USD This index measures the

is a comprehensive representation of the US

investment grade corporate bond market.
examines the weighted average of prices of
a basket of consumer goods and services.
JOBS OPENINGS AND LABOR TURNOVER
SURVEY (JOLTS) This monthly survey,

conducted by the Bureau of Labor Statistics,

collects data on job openings, hires and
separations from some 16,000 US
businesses. It covers all nonagricultural
industries in the public and private sectors
for the 50 states and the District of
Columbia.
MERRILL LYNCH OPTION VOLATILITY
ESTIMATE (MOVE) INDEX This is a yield-

curve-weighted index of the normalized

implied volatility on one-month US
Treasury options.
MORGAN STANLEY COMBINED MARKET
TIMING INDICATOR (CMTI) The CMTI is an

performance of France sovereign bonds in

the seven-to-10-year maturity range and is
denominated in US dollars.

average across the Risk, Fundamentals and

Composite Valuation Indicators.

CITI GERMANY GBI CURRENCY HEDGED 7

TO 10 YEAR USD This index measures the

MORGAN STANLEY EQUITY RISK

INDICATOR This is a proprietary sentiment

performance of Germany sovereign bonds

in the seven-to-10-year maturity range and
is denominated in US dollars.

and risk indicator for US equities.

MORGAN STANLEY GLOBAL RISK DEMAND
INDEX This index tracks risk sentiment as

a
free-float-adjusted market capitalization
index that is designed to measure equity
market performance in the global developed
and emerging markets.

MSCI EAFE INDEX This capitalizationweighted index tracks the total return of
stocks in 21 developed-market countries in
Europe, Australia and the Far East.
NFIB INDEX OF SMALL BUSINESS OPTIMISM

This sentiment index is based on a survey of

small businesses drawn from the
membership of the National Federation of
Independent Businesses.
PRODUCER PRICE INDEX This index

measures wholesale price levels in the

economy.
RUSSELL 1000 INDEX This

index measures
the performance of the 1,000 largest US
companies based on total market
capitalization.

RUSSELL 1000 GROWTH INDEX This index

measures the performance of those Russell
1000 companies with higher price-to-book
ratios and higher forecasted growth.
RUSSELL 1000 VALUE INDEX This index
measures the performance of those Russell
1000 companies with lower price-to-book
ratios and lower forecasted growth.

This index measures

the performance of the 2,000 smallest
companies in the Russell 3000 Index.

RUSSELL 2000 INDEX

RUSSELL 3000 INDEX This

index measures
the performance of the 3,000 largest US
companies based on total market
capitalization.

S&P 500 INDEX This capitalization-weighted

index includes a representative sample of
500 leading companies in leading industries
in the US economy.

reflected in the relative price movements of

Please refer to important information, disclosures and qualifications at the end of this material.

Aug. 17, 2015 9

THE GIC WEEKLY

Risk Considerations
MLPs
Master Limited Partnerships (MLPs) are limited partnerships or limited liability companies that are taxed as partnerships and whose interests (limited
partnership units or limited liability company units) are traded on securities exchanges like shares of common stock. Currently, most MLPs operate in
the energy, natural resources or real estate sectors. Investments in MLP interests are subject to the risks generally applicable to companies in the
energy and natural resources sectors, including commodity pricing risk, supply and demand risk, depletion risk and exploration risk.
Individual MLPs are publicly traded partnerships that have unique risks related to their structure. These include, but are not limited to, their reliance
on the capital markets to fund growth, adverse ruling on the current tax treatment of distributions (typically mostly tax deferred), and commodity
volume risk.
The potential tax benefits from investing in MLPs depend on their being treated as partnerships for federal income tax purposes and, if the MLP is
deemed to be a corporation, then its income would be subject to federal taxation at the entity level, reducing the amount of cash available for
distribution to the fund which could result in a reduction of the funds value.
MLPs carry interest rate risk and may underperform in a rising interest rate environment. MLP funds accrue deferred income taxes for future tax
liabilities associated with the portion of MLP distributions considered to be a tax-deferred return of capital and for any net operating gains as well as
capital appreciation of its investments; this deferred tax liability is reflected in the daily NAV; and, as a result, the MLP funds after-tax performance
could differ significantly from the underlying assets even if the pre-tax performance is closely tracked.

Duration
Duration, the most commonly used measure of bond risk, quantifies the effect of changes in interest rates on the price of a bond or bond portfolio.
The longer the duration, the more sensitive the bond or portfolio would be to changes in interest rates. Generally, if interest rates rise, bond prices
fall and vice versa. Longer-term bonds carry a longer or higher duration than shorter-term bonds; as such, they would be affected by changing
interest rates for a greater period of time if interest rates were to increase. Consequently, the price of a long-term bond would drop significantly as
compared to the price of a short-term bond.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and
economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets,
since these countries may have relatively unstable governments and less established markets and economies.
Alternative investments which may be referenced in this report, including private equity funds, real estate funds, hedge funds, managed futures
funds, and funds of hedge funds, private equity, and managed futures funds, are speculative and entail significant risks that can include losses due to
leveraging or other speculative investment practices, lack of liquidity, volatility of returns, restrictions on transferring interests in a fund, potential lack
of diversification, absence and/or delay of information regarding valuations and pricing, complex tax structures and delays in tax reporting, less
regulation and higher fees than mutual funds and risks associated with the operations, personnel and processes of the advisor.
Managed futures investments are speculative, involve a high degree of risk, use significant leverage, have limited liquidity and/or may be generally
illiquid, may incur substantial charges, may subject investors to conflicts of interest, and are usually suitable only for the risk capital portion of an
investors portfolio. Before investing in any partnership and in order to make an informed decision, investors should read the applicable prospectus
and/or offering documents carefully for additional information, including charges, expenses, and risks. Managed futures investments are not intended
to replace equities or fixed income securities but rather may act as a complement to these asset categories in a diversified portfolio.
Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to,
(i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events,
war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence,
technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary
distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.
Physical precious metals are non-regulated products. Precious metals are speculative investments, which may experience short-term and long
term price volatility. The value of precious metals investments may fluctuate and may appreciate or decline, depending on market conditions. If sold
in a declining market, the price you receive may be less than your original investment. Unlike bonds and stocks, precious metals do not make interest
or dividend payments. Therefore, precious metals may not be suitable for investors who require current income. Precious metals are commodities
that should be safely stored, which may impose additional costs on the investor. The Securities Investor Protection Corporation (SIPC) provides
certain protection for customers cash and securities in the event of a brokerage firms bankruptcy, other financial difficulties, or if customers assets
are missing. SIPC insurance does not apply to precious metals or other commodities.
Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk.
Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date.
The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the
maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the
risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk
that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Please refer to important information, disclosures and qualifications at the end of this material.

Aug. 17, 2015 10

THE GIC WEEKLY

Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, including greater
credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives
and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio.
Interest on municipal bonds is generally exempt from federal income tax; however, some bonds may be subject to the alternative minimum tax
(AMT). Typically, state tax-exemption applies if securities are issued within one's state of residence and, if applicable, local tax-exemption applies if
securities are issued within one's city of residence.
Treasury Inflation Protection Securities (TIPS) coupon payments and underlying principal are automatically increased to compensate for inflation
by tracking the consumer price index (CPI). While the real rate of return is guaranteed, TIPS tend to offer a low return. Because the return of TIPS is
linked to inflation, TIPS may significantly underperform versus conventional U.S. Treasuries in times of low inflation.
Principal is returned on a monthly basis over the life of a mortgage-backed security. Principal prepayment can significantly affect the monthly
income stream and the maturity of any type of MBS, including standard MBS, CMOs and Lottery Bonds. Yields and average lives are estimated
based on prepayment assumptions and are subject to change based on actual prepayment of the mortgages in the underlying pools. The level of
predictability of an MBS/CMOs average life, and its market price, depends on the type of MBS/CMO class purchased and interest rate movements.
In general, as interest rates fall, prepayment speeds are likely to increase, thus shortening the MBS/CMOs average life and likely causing its market
price to rise. Conversely, as interest rates rise, prepayment speeds are likely to decrease, thus lengthening average life and likely causing the
MBS/CMOs market price to fall. Some MBS/CMOs may have original issue discount (OID). OID occurs if the MBS/CMOs original issue price is
below its stated redemption price at maturity, and results in imputed interest that must be reported annually for tax purposes, resulting in a tax
liability even though interest was not received. Investors are urged to consult their tax advisors for more information.
Asset-backed securities generally decrease in value as a result of interest rate increases, but may benefit less than other fixed-income securities
from declining interest rates, principally because of prepayments.
Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.
Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.
Companies paying dividends can reduce or cut payouts at any time.
Investing in smaller companies involves greater risks not associated with investing in more established companies, such as business risk,
significant stock price fluctuations and illiquidity.
Stocks of medium-sized companies entail special risks, such as limited product lines, markets, and financial resources, and greater market
volatility than securities of larger, more-established companies.
Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their
business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected.
Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these
high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations.
Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.
The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the
performance of any specific investment.
The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes. Morgan
Stanley Smith Barney LLC retains the right to change representative indices at any time.
Credit ratings are subject to change.
REITs investing risks are similar to those associated with direct investments in real estate: property value fluctuations, lack of liquidity, limited
diversification and sensitivity to economic factors such as interest rate changes and market recessions.
Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.
Rebalancing does not protect against a loss in declining financial markets. There may be a potential tax implication with a rebalancing strategy.
Investors should consult with their tax advisor before implementing such a strategy.
Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency,
economic and market risks.
Investing in foreign markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and
market risks. Investing in currency involves additional special risks such as credit, interest rate fluctuations, derivative investment risk, and
domestic and foreign inflation rates, which can be volatile and may be less liquid than other securities and more sensitive to the effect of varied
economic conditions. In addition, international investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These
risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in
countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.
Certain securities referred to in this material may not have been registered under the U.S. Securities Act of 1933, as amended, and, if not, may not
be offered or sold absent an exemption therefrom. Recipients are required to comply with any legal or contractual restrictions on their purchase,
holding, and sale, exercise of rights or performance of obligations under any securities/instruments transaction.

Please refer to important information, disclosures and qualifications at the end of this material.

Aug. 17, 2015 11

THE GIC WEEKLY

Disclosures
Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC, a registered broker-dealer in the United States. This
material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or
other financial instrument or to participate in any trading strategy. Past performance is not necessarily a guide to future performance.
The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors,
including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors.
Morgan Stanley Wealth Management is involved in many businesses that may relate to companies, securities or instruments mentioned in this
material.
This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any
security/instrument, or to participate in any trading strategy. Any such offer would be made only after a prospective investor had completed its own
independent investigation of the securities, instruments or transactions, and received all information it required to make its own investment decision,
including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain
material information not contained herein and to which prospective participants are referred. This material is based on public information as of the
specified date, and may be stale thereafter. We have no obligation to tell you when information herein may change. We make no representation or
warranty with respect to the accuracy or completeness of this material. Morgan Stanley Wealth Management has no obligation to provide updated
information on the securities/instruments mentioned herein.
The securities/instruments discussed in this material may not be suitable for all investors. The appropriateness of a particular investment or strategy
will depend on an investors individual circumstances and objectives. Morgan Stanley Wealth Management recommends that investors
independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor. The value of and
income from investments may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates,
securities/instruments prices, market indexes, operational or financial conditions of companies and other issuers or other factors. Estimates of future
performance are based on assumptions that may not be realized. Actual events may differ from those assumed and changes to any assumptions
may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the
projections or estimates. Certain assumptions may have been made for modeling purposes only to simplify the presentation and/or calculation of any
projections or estimates, and Morgan Stanley Wealth Management does not represent that any such assumptions will reflect actual future events.
Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or performance results will not
materially differ from those estimated herein.
This material should not be viewed as advice or recommendations with respect to asset allocation or any particular investment. This information is
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acting as a fiduciary under either the Employee Retirement Income Security Act of 1974, as amended or under section 4975 of the Internal Revenue
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Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Financial Advisors do not provide legal or tax advice. Each client
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2015 Morgan Stanley Smith Barney LLC. Member SIPC.

Please refer to important information, disclosures and qualifications at the end of this material.

Aug. 17, 2015 12