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2014 Midyear UpdateNick SargenChief Economist

Introducing the Stanford Colts!

Investment Results (annual total returns in %)

*Includes dividends except for Emerging Markets, which is price change Source: Bloomberg

2013 2014 1st HalfEquities*

S&P 500 32.4 7.1EAFE ($) 22.8 4.8

EM($) -2.6 6.1Bonds

Treasuries -2.8 2.7Corporates -2.0 5.7High Yield 7.4 5.6EMBI ($) -5.2 8.7

For Internal Use Only 3

4

What was Priced into Markets?

♦ 2014: A Breakout Year for U.S.

♦ Improved Performances (Diminished Risks) Abroad

♦ Fed ends QE, but refrains from tightening

5

Source: Barron’s

6

Treasury Yield Curve

Source: Bloomberg

0YR 1YR 2YR 5YR 7YR 10YR 30YR

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

12/31/2013 7/31/2014

7

Federal Funds Futures Expectations

Jul-1

4

Aug-1

4

Sep-1

4

Oct-1

4

Nov-1

4

Dec-1

4

Jan-

15

Feb-1

5

Mar

-15

Apr-1

5

May

-15

Jun-

15

Jul-1

5

Aug-1

5

Sep-1

5

Oct-1

5

Nov-1

5

Dec-1

5

Jan-

16

Feb-1

6

Mar

-16

Apr-1

6

May

-16

Jun-

160.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

4/30/2014 7/5/2013 7/31/2014

Source: Bloomberg

The Fed’s Twin Objective: Inflation and Unemployment

Source: BLS, BEA

Dec-99

Jul-00

Feb-01

Sep-01

Apr-02

Nov-02

Jun-03

Jan-04

Aug-04

Mar-05

Oct-05

May-06

Dec-06

Jul-07

Feb-08

Sep-08

Apr-09

Nov-09

Jun-10

Jan-11

Aug-11

Mar-12

Oct-12

May-13

Dec-13

0.0

2.0

4.0

6.0

8.0

10.0

12.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Unemployment Rate (Right) Core PCE YoY (Left)

%

8

Inflation Expectations

Source: Bloomberg

9

Jul-0

5

Oct-0

5

Jan-

06

Apr-0

6

Jul-0

6

Nov-0

6

Feb-0

7

May

-07

Aug-0

7

Dec-0

7

Mar

-08

Jun-

08

Sep-0

8

Dec-0

8

Apr-0

9

Jul-0

9

Oct-0

9

Jan-

10

May

-10

Aug-1

0

Nov-1

0

Feb-1

1

May

-11

Sep-1

1

Dec-1

1

Mar

-12

Jun-

12

Oct-1

2

Jan-

13

Apr-1

3

Jul-1

3

Oct-1

3

Feb-1

4

May

-14

1.75

1.95

2.15

2.35

2.55

2.75

2.95

3.15

3.35

3.55

3.75

5 Year Forward 5 Year Inflation Expectations

10

Two Views of the Economy: Real GDP Growth vs. Nonfarm Payrolls Growth

Dec-9

9

Jun-

00

Dec-0

0

Jun-

01

Dec-0

1

Jun-

02

Dec-0

2

Jun-

03

Dec-0

3

Jun-

04

Dec-0

4

Jun-

05

Dec-0

5

Jun-

06

Dec-0

6

Jun-

07

Dec-0

7

Jun-

08

Dec-0

8

Jun-

09

Dec-0

9

Jun-

10

Dec-1

0

Jun-

11

Dec-1

1

Jun-

12

Dec-1

2

Jun-

13

Dec-1

3

Jun-

14

-10.0%

-8.0%

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

Real GDP QoQ % (left) NFP QoQ % (right)

Source: BEA

11

Read GDP Growth and Fiscal Drag

Source: BEA

12/1

/200

8

3/1/

2009

6/1/

2009

9/1/

2009

12/1

/200

9

3/1/

2010

6/1/

2010

9/1/

2010

12/1

/201

0

3/1/

2011

6/1/

2011

9/1/

2011

12/1

/201

1

3/1/

2012

6/1/

2012

9/1/

2012

12/1

/201

2

3/1/

2013

6/1/

2013

9/1/

2013

12/1

/201

3

3/1/

2014

6/1/

2014

90.0%

95.0%

100.0%

105.0%

110.0%

115.0%

Real GDP ex Govt Govt Spending

Business Surveys Have Improved RecentlyD

ec-9

9Ju

n-00

Dec

-00

Jun-

01D

ec-0

1Ju

n-02

Dec

-02

Jun-

03D

ec-0

3Ju

n-04

Dec

-04

Jun-

05D

ec-0

5Ju

n-06

Dec

-06

Jun-

07D

ec-0

7Ju

n-08

Dec

-08

Jun-

09D

ec-0

9Ju

n-10

Dec

-10

Jun-

11D

ec-1

1Ju

n-12

Dec

-12

Jun-

13D

ec-1

3Ju

n-14

25

30

35

40

45

50

55

60

65

ISM Manufacturing and Services

ISM Manuf ISM Non-Manuf

Source: ISM, Bloomberg

For Internal Use Only 12

13

Global Surveys Point to Moderate Economic GrowthD

ec-0

7F

eb-0

8A

pr-0

8Ju

n-08

Aug

-08

Oct

-08

Dec

-08

Feb

-09

Apr

-09

Jun-

09A

ug-0

9O

ct-0

9D

ec-0

9F

eb-1

0A

pr-1

0Ju

n-10

Aug

-10

Oct

-10

Dec

-10

Feb

-11

Apr

-11

Jun-

11A

ug-1

1O

ct-1

1D

ec-1

1F

eb-1

2A

pr-1

2Ju

n-12

Aug

-12

Oct

-12

Dec

-12

Feb

-13

Apr

-13

Jun-

13A

ug-1

3O

ct-1

3D

ec-1

3F

eb-1

4A

pr-1

4Ju

n-14

30

35

40

45

50

55

60

65

JP Morgan Global Manufacturing PMI JP Morgan Global Services PMISource: JP Morgan, Bloomberg

%

14

Tensions in the Euro-zone have Lessened….

Jul-1

0

Aug-1

0

Sep-1

0

Oct-1

0

Dec-1

0

Jan-

11

Feb-1

1

Apr-1

1

May

-11

Jun-

11

Aug-1

1

Sep-1

1

Oct-1

1

Dec-1

1

Jan-

12

Feb-1

2

Apr-1

2

May

-12

Jun-

12

Jul-1

2

Sep-1

2

Oct-1

2

Nov-1

2

Jan-

13

Feb-1

3

Mar

-13

May

-13

Jun-

13

Jul-1

3

Sep-1

3

Oct-1

3

Nov-1

3

Jan-

14

Feb-1

4

Mar

-14

May

-14

Jun-

14

Jul-1

4

0

1

2

3

4

5

6

7

8

10Y Italy 10Y Spain 10Y Germany

Source: Bloomberg

%

Government Yields

Oil Prices Have Been Steady Despite Increased Tensions

Source: Bloomberg

Sep-9

9Feb

-00

Jul-0

0Dec

-00

May

-01

Oct-0

1M

ar-0

2Aug

-02

Jan-

03Ju

n-03

Nov-0

3Apr

-04

Sep-0

4Feb

-05

Jul-0

5Dec

-05

May

-06

Oct-0

6M

ar-0

7Aug

-07

Jan-

08Ju

n-08

Nov-0

8Apr

-09

Sep-0

9Feb

-10

Jul-1

0Dec

-10

May

-11

Oct-1

1M

ar-1

2Aug

-12

Jan-

13Ju

n-13

Nov-1

3Apr

-14

$0

$20

$40

$60

$80

$100

$120

$140

$160

Brent Crude $Px

For Internal Use Only 15

16

Has China Mortgaged its Future?

♦ China withstood the Great Recession remarkably well

♦ But it deployed a tidal wave of credit

♦ Economic growth of 7% - 8% is likely to slow over time

♦ China’s leaders are embarking on a new set of policy reforms

♦ But internal political tensions are increasing

For Internal Use Only

Where are we in the Economic Cycle?

Recession Recovery

Late Cycle(inflation)

PB

PB

PS PS

Expansion

17

18

Share of Labor Income vs. Corporate Profits

Source: Bureau of Economic Analysis

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

2011

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

49.0%

50.0%

51.0%

52.0%

53.0%

54.0%

55.0%

56.0%

57.0%

58.0%

59.0%

Corp Profit % GDP (Left) Labor % of GDP (Right)

19

Portfolio Positioning

♦ Maintain a tilt in favor of stocks over bonds

♦ Stocks are no longer cheap; however, the market is not frothy

♦ Stronger growth would bring the Fed into play sooner

♦ Weaker growth would imply earnings disappointment