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SVB Q1 2017 Economic Report

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The SVB Asset Management Economic Report, Q1 2017, is a review of and outlook on economic and market factors that impact global markets and business health.

In this edition, the team discusses the Fed's recent activity and its intentions to raise benchmark interest rates three times in 2017. The report also focuses on how the new U.S. administration will impact domestic and global economies.

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SVB Q1 2017 Economic Report

  1. 1. Q1 Quarterly Economic Report 2017
  2. 2. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Table of Contents 2 Thoughts from the desk 3 Overview 4 Domestic economy 6 Central bank monetary policy 12 Markets and performance 17 Global economy 24 Portfolio management strategy 28
  3. 3. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Thoughts from the desk Perking up for 2017 Nap time is over. After a sleepy third quarter, financial markets woke up late in the year and vigorously reacted to a flurry of activity and data. The chief catalyst was the surprise election of a new Commander-in-Chief. After initial unease, financial markets took a liking to the prospects of President Trump and a Republican controlled Congress, seeing an opportunity for tax cuts, spending increases, and less regulation. But the anticipated fiscal stimulus, along with a more hawkish Federal Reserve, rings in the New Year with slightly elevated uncertainty. As the U.S. economy enters the later stages of the business cycle, the Fed announced its intentions to gradually raise its benchmark interest rate three times in 2017. Policy shifts, both monetary and fiscal, could impact confidence in the U.S. economy. Although the economy is expected to continue its growth trajectory in the low-2 percent range, any added stimulus might push growth to 2.5 percent in the latter half of 2017. Should a meaningful spending package become reality, the U.S. economy will likely benefit from continued robust consumer spending, rising construction activity, and a rebound in business investment. However, there are several key risks worth monitoring. On the trade front, global markets would not react well to new U.S. protectionist policies. And should the Fed continue to remove monetary accommodations, the dollar would be expected to rise. However, a much stronger dollar could be a drag on net exports and real GDP. Strong recent economic data, including the decline in unemployment to a nine-year low, rising wages, and a robust recovery in energy prices should help push inflation up to the Fed’s 2 percent preferred target in the medium term. This inflationary momentum would validate any anticipated rate hikes in 2017. Perhaps the bigger question is: Will the current economic momentum, coupled with fewer regulatory constraints, boost economic growth beyond the Fed’s current projections? There are, of course, risks, and any monetary or fiscal policy missteps could stall economic growth. For example, the Fed could raise rates too quickly. Or the new administration’s trade amendments might even lead to a trade war. Given these risks, we continue to favor a conservative approach to duration and believe that an overweight position to short maturity corporate credits is a sensible way to capture income. We also believe that a tactical allocation to government securities could be prudent in an environment of fiscal uncertainty and less monetary accommodations. 3
  4. 4. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Overview  Following a muted third quarter, volatility has re-emerged primarily due to the U.S. presidential election. Current market dynamics may prove to be somewhat temporary as fiscal policy plans are laid out. However, the Federal Reserve responded by tightening monetary policy.  At the December FOMC meeting, the Federal Reserve raised the Fed Funds target rate for the first time in 2016, attributing the action to their view of both realized and expected labor market conditions and inflation. The rate increased by 25 basis points to a range between 0.50 and 0.75 percent.  Looking ahead, Fed members’ rate projections indicate a steeper path for interest rates in 2017. Based on median rates, the Committee expects three quarter-point rate increases in 2017.  Compared to other major economies, the U.S. stands alone as being in a tightening mode. Other central banks continue to monitor the effects of earlier stimulus on the economies to judge whether additional monetary easing may be needed. Central bank monetary policy  Economic activity has been healthy with Q3 GDP at 3.5 percent. The third revision revealed stronger spending than was originally estimated on services, intellectual property and construction by state and local governments.  The latest GDP figure supported the Federal Reserve’s case for raising the Federal Funds rate for the first time since 2015.  Consumer sentiment spiked in December following Donald Trump’s victory as consumers viewed the win as positive for their finances and the U.S. economy.  In 2016, the U.S. economy added over two million jobs, maintaining the trend over the last few years of more than two million jobs added per year.  The unemployment rate has run below five percent for the majority of the year. Minutes from the last FOMC meeting of 2016 showed that participants anticipate the unemployment rate will run below normal longer-run levels.  Wage growth jumped in December to 2.9 percent. If the trend continues, it will add to future inflationary pressures and support the case for further rate hikes by the Federal Reserve. Domestic economy 4
  5. 5. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Overview  Major economies firmed to end 2016. Even with numerous headwinds present –– particularly political uncertainties –– economic activity was primarily in expansion mode, and in some areas growth was at a healthy clip.  Canada’s economy is rebounding from low oil prices, with growth accelerating into the year-end helped by consumer spending and exports. The country still faces numerous challenges, including a hot real estate market and rising household debt. Nonetheless, bank asset quality remains steady and the country may benefit from a weaker currency and supportive monetary policy.  Australia continued to grow through the recent commodity bust as the economy expanded, in part, from favorable demographics. While growth slowed into year-end and the labor market is in a mild recovery, domestic demand has been supportive of a stable economy.  Stability in the Nordic region endures, with low oil price concerns alleviated. While the region is marred by elevated housing prices, asset quality at banks remains strong. In Norway, a rise in government spending is propping up the economy, while economic conditions in Sweden remain strong. Domestic demand and an improving labor market underpin Denmark’s stability, while Finland’s banking system was named the world’s safest by the World Economic Forum. Global economy  U.S. investment grade and high-yield spreads closed 2016 at their tightest levels since April 2015 and September 2014, respectively. At the sector level, utilities/energy outperformed as spreads tightened, largely due to stable oil prices following the OPEC agreement.  U.S. equities saw solid gains in 2016, buoyed by a post-election rally that pushed the major indices close to their all-time highs.  The prospect of increased fiscal stimulus, higher inflation and a brighter assessment of U.S growth resulted in higher U.S. Treasury rates making it the worst-performing sector on a total return basis.  Corporate credit fundamentals remain solid overall, particularly among larger and higher-quality companies. Credit metrics remained little changed from the previous quarter across all sectors.  Investment-grade corporate spreads generally tightened over 2016 and fundamentals are expected to remain resilient in 2017. Markets and performance 5
  6. 6. Domestic economy
  7. 7. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 Percent Personal consumption Gross private domestic investment Net exports Government GDP  Economic activity has been healthy with Q3 GDP at 3.5 percent. The third revision revealed stronger spending than was originally estimated on services, intellectual property and construction by state and local governments.  The latest GDP figure supported the Federal Reserve’s case for raising the Federal Funds rate for the first time since 2015.  The Q3 pickup in GDP was the fastest acceleration since Q3 2014. However, it is unlikely to remain sustainable given that it was driven by a jump in exports. Despite potentially lower readings in upcoming GDP figures, growth should be strong enough to support the job market and, in turn, contribute to higher wage growth and robust consumer spending. GDP: Picking-up speed GDP and components Source: Bureau of Economic Analysis (BEA), Congressional Budget Office (CBO) and SVB Asset Management. Data as of 12/31/2016. Note: GDP values shown in legend are % change vs. prior quarter, on an annualized basis. 7
  8. 8. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Consumption: Optimism spreads Consumption overview Consumer sentimentRetail and food service sales  Q3 data showed a three percent increase in consumer spending quarter- over-quarter. While not as robust as the prior quarter growth, it is still a strong reading.  Personal savings continued to creep down slightly. The recent downward trend supports the view that consumers are feeling more confident in the U.S. economy.  Retail sales came in below expectations with purchases increasing only 0.1 percent in November. The lower figure shows a slight slowdown in recent consumer spending compared to prior months.  Consumer sentiment spiked in December following Donald Trump’s victory as consumers viewed the win as positive for their finances and the U.S. economy. Source: Bloomberg and SVB Asset Management. Data as of 12/31/2016. 8 0.0 20.0 40.0 60.0 80.0 100.0 120.0 140.0 -6.0 -4.0 -2.0 0.0 2.0 4.0 6.0 8.0 10.0 Percent Percent Personal consumption (LHS) Personal savings (LHS) Household debt to disposable income ratio (RHS) 40.0 50.0 60.0 70.0 80.0 90.0 100.0 110.0 120.0 UniversityofMichigan ConsumerSentimentIndex Average 5.0 7.0 9.0 11.0 13.0 15.0 17.0 19.0 21.0 23.0 25.0 250.0 300.0 350.0 400.0 450.0 500.0 Vehiclesales($millions) Retail&foodservicessales ($billions) Ex autos (LHS) Vehicle sales (RHS)
  9. 9. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Employment: Solid pace Labor force participation rateEmployment landscape Employment to population ratio  The December payroll report of 156,000 was below expectations, but was still strong for an economy that is largely considered at full employment.  In 2016, the U.S. economy added over two million jobs, maintaining the trend over the last few years of more than two million jobs added per year.  The unemployment rate has run below five percent for the majority of the year. The minutes from the last FOMC meeting of 2016 showed that participants anticipate the unemployment rate will run below normal longer-run levels.  The participation rate continues to hover at low levels due to baby boomers retiring and others still out of work and on the sidelines. Source: U.S. Bureau of Labor and Statistics (BLS), Bloomberg and SVB Asset Management. Data as of 1/6/2017. Note: The underemployment rate U-6 defined as persons marginally attached to the labor force are those who currently are neither working nor looking for work, but indicate they want and are available for a job and have looked for work in the past 12 months. 9 -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 -1,000.0 -500.0 0.0 500.0 1,000.0 Percent Thousands Non-farm payroll (LHS) Unemployment rate (RHS) U-6 (RHS) 0.0 2.0 4.0 6.0 8.0 10.0 12.0 62 63 64 65 66 67 68 Percent Labor force participation rate (LHS) Unemployment rate (RHS) 55 56 57 58 59 60 61 62 63 64
  10. 10. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 U.S. housing: Firm footing Home prices — indexed to 100Home sales and supply Household formationHousing affordability Source: Bloomberg and SVB Asset Management. Data as of 12/31/2016. 10 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 3.0 4.0 5.0 6.0 7.0 8.0 9.0 Homesupply(months) Homesales(millions) Total sales (new & existing) Existing home supply 0 50 100 150 200 250 300 Median home price FHFA purchase Case-Schiller 20 city 0.0 2.0 4.0 6.0 8.0 10.0 12.0 0.0 50.0 100.0 150.0 200.0 250.0 Percent Affordabilityindex Housing affordability 30 -year fixed mortgage rates -3000 -2000 -1000 0 1000 2000 3000 4000 Thousands
  11. 11. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Inflation: Higher expectations Crude oil and gasoline pricesCore PCE — % change from prior year Wage growth  Core PCE continues to trend closer to the Fed’s two percent target, supporting the December 2016 decision to raise the Federal Funds rate.  OPEC’s decision in November to reduce output by 1.2 million barrels a day to 32.5 million for six months helped stabilize oil prices and should apply some inflationary pressure. The reduction began in January 2017.  Wage growth jumped in December to 2.9 percent. If the trend continues, it will add to future inflationary pressures and support the case for further rate hikes by the Federal Reserve. Source: Bloomberg and SVB Asset Management. Data as of 12/31/2016. 11 1.5 2.0 2.5 3.0 3.5 4.0 Annualpercentagechange 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 0.0 20.0 40.0 60.0 80.0 100.0 120.0 140.0 160.0 Priceperbarrel($) Crude oil (LHS) Daily national average of gasoline prices (RHS) 0.0 1.0 2.0 3.0 4.0 5.0 %changefromprioryear Core PCE Fed target Monetary policy threshold
  12. 12. Central bank monetary policy
  13. 13. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Despite strengthening employment and inflation in the U.S., the Fed refrains from a second rate hike during the quarter as global conditions continue to pose risks. A recovery in oil and hawkish Fedspeak earlier in the quarter drive interest rates temporarily higher. The yield on the 2-year Treasury note hits 92 basis points in May. Following Brexit, Treasury yields experience a period of low volatility for much of the summer. We also saw a flatter yield curve as evidenced by the tighter spread. Following a period of low volatility, interest rates break out of trading ranges and head higher on the heels of the presidential election  given prospects for greater fiscal spending. Central banks around the world implement additional easing measures, with the BOJ adopting a negative interest rate policy, China cuts reserve requirements and the ECB expands their asset purchase program into the corporate bond market. A confluence of factors in June brings rates back down to H1 2015 levels. At center stage is Brexit, which sent investors towards safe havens such as U.S. Treasuries. A disappointing employment report and a dovish tilt from the FOMC meeting also lowers probabilities for future rate hikes. Solid employment reports and inflation readings drive hawkish comments from Fed members and temporarily increase probabilities for a rate hike. At the September FOMC meeting, they announce a stronger case for a rate hike, but decide to wait for further evidence of continued progress towards their objectives. Continued strength in economic data  specifically, the decline in the unemployment rate to a nine-year low, inflation hovering around the Fed’s 2 percent target and expectations for greater inflationary pressures –– prompts the Fed to raise the target range for the Federal Funds rate at year-end. After hitting recent lows, oil prices see some stabilization towards quarter-end as world leaders discuss a production freeze. Markets are focused on the broader implications of Brexit, while central banks such as the ECB and Fed stand ready to provide liquidity if needed. Looking ahead, the Fed continues to stress a gradual approach to raising interest rates. The Fed’s median forecast projects one interest rate increase for the remainder of 2016. OPEC agrees to cut production, sending oil prices higher and creating more inflationary pressure. Historical interest rates: Upward trajectory Source: Bloomberg and SVB Asset Management. Data as of December 30, 2016. 13 0.0 0.2 0.4 0.6 0.8 1.0 1.2 Percent 2-year Treasury yield 1-year Treasury yield
  14. 14. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Central bank economic projections: Brighter outlook 14 2015 2016 2017 2018 Economic projections: United States Change in real GDP 2.6% 1.9% 2.1% 2.0% Unemployment rate 5.3% 4.7% 4.5% 4.5% Core PCE inflation 1.4% 1.7% 1.8% 2.0% Economic projections: Eurozone Change in real GDP 2.0% 1.7% 1.7% 1.6% CPI inflation 0.0% 0.2% 1.3% 1.5% Unemployment rate 10.9% 10.1% 9.9% 9.6% Economic projections: China Change in real GDP 6.9% CPI inflation 1.4% Unemployment rate 4.1% Economic projects: Japan Change in real GDP 1.2% 1.0% 1.3% 0.9% CPI inflation 0.8% 0.1% 1.7% 1.9% Source: Federal Reserve, European Central Bank, National People’s Congress of China, Bank of Japan. Data as of December 20, 2016. Forecasts are not available for all periods.
  15. 15. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 PercentFederal Reserve rate projections: Expectations accelerate Source: Bloomberg and Federal Reserve. Data as of December 14, 2016. Percentages below the chart reference the median forecasted rate at the end of each period. September 2016 median 0.375% 0.625% 1.125% 1.875% 2.625% 2.875% June 2016 median 0.375% 0.875% 1.625% 2.375% – 3.00% March 2016 median 0.375% 0.875% 1.875% 3.000% – 3.25% 15
  16. 16. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Japan Eurozone United Kingdom China United States Central bank Bank of Japan European Central Bank Bank of England People's Bank of China Federal Reserve Benchmark rate -0.10 percent 0.0 percent 0.25 percent 4.35 percent 0.50-0.75 percent Current policy Maintaining current easing program, which includes, 10-year rates near zero and commitmentto push inflation above 2 percent Maintaining previous cuts on refinancing rate and deposit rate with no change to its expanded QE program • August rate cut in response to EU referendum outcome • No action taken in September • No additional action since February’s 50 basis points reserve ratio cut • Lending and deposit rates hold steady Considering additional rate hikes after increasing rates by 25 basis points in December Inflation Unemployment 3.1% 9.6% 4.8% 4.0% 4.7% Analysis No material policy changes expected for 2017 given recent Yen weakness No additional action projected, but skewed towards more easing or refinement of current QE program No additional action likely near term, with direction of inflation and economic activity uncertain Recent economic improvements reduce the need for further rate and reserve ratio cuts in 2017 Anticipating additional interest rate increases in 2017 EasingEasing Stable Tightening Central banks: Wait and see Source: Federal Reserve, European Central Bank, Bank of England, The People’s Bank of China, Bank of Japan, Bloomberg, SVB Asset Management 16 0.20% 0.0% 1.0% 2.0% 0.60% 0.0% 1.0% 2.0% 1.2% 0.0% 1.0% 2.0% 2.3% 0.0% 1.0% 2.0% 3.0% 1.4% 0.0% 1.0% 2.0%
  17. 17. Markets and performance
  18. 18. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Basic statistics Spread change Total return % Excess return % Spread Yield Duration QTD YTD QTD YTD QTD YTD 1-3yr Treasuries 0.00 1.18 1.89 0.00 0.00 -0.43 0.89 0.00 0.00 1-3yr agencies 12.00 1.31 1.88 -1.00 3.00 -0.35 0.95 0.07 0.09 0-3yr MBS 38.00 2.06 2.10 9.00 20.00 -1.05 0.19 -0.59 -0.92 1-3yr ABS 68.00 1.67 1.27 -5.00 -16.00 -0.02 1.83 0.20 1.02 1-3yr IG corporates 88.00 2.06 1.86 1.00 -20.00 -0.21 2.38 0.25 1.41 3-5yr IG corporates 104.00 2.76 3.68 0.00 -32.00 -1.56 3.60 0.31 2.32 5-10yr IG corporates 132.00 3.57 6.40 -14.00 -53.00 -3.18 5.84 1.19 4.33 1-5yr high yield 510.00 6.65 2.39 -75.00 -340.00 2.59 16.09 3.56 14.95 1-3yr corporates by rating AAA 34.00 1.57 2.08 -2.00 12.00 -0.38 1.19 0.18 0.15 AA 62.00 1.79 1.89 3.00 6.00 -0.34 1.56 0.15 0.58 A 78.00 1.94 1.83 2.00 -3.00 -0.26 1.90 0.19 0.91 BBB 115.00 2.33 1.86 -1.00 -57.00 -0.09 3.44 0.37 2.52 1-3yr corporates by sector Financial 93.00 2.10 1.83 0.00 -3.00 -0.19 2.02 0.27 1.08 Industrials 84.00 2.02 1.87 2.00 -32.00 -0.22 2.62 0.24 1.63 Utility/energy 93.00 2.10 1.86 5.00 -25.00 -0.30 2.55 0.17 1.59 Fixed income returns: Overview Spread is based on Govt Option Adjusted Spread. Duration is based on Macaulay duration. Data as of December 31, 2016. Source: Bloomberg, BofA Merrill Lynch and SVB Asset Management. 18
  19. 19. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Total return comparisons: Fixed income lags All returns above are on total return basis. 2016 returns are on an annualized basis up to December 30, 2016. FI Credit refers to BofA/ML US Corporate Bonds 1-3 year Index; Treasury refers to BofA/ML US Treasuries 1-3 year Index; Gold refers to S&P GSCI Gold Spot; WTI refers to Spot West Texas Intermediate Crude Oil; Wilshire refers to Wilshire 5000 Total Market Index; REIT refers to MSCI US REIT Index; S&P 500 refers to S&P 500 Index. Source: Thomson Reuters, Barclays Live and SVB Asset Management 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 WTI 57.68% US Treasury 6.67% WTI 78.00% Gold 29.67% Gold 10.23% REIT 16.47% Wilshire 33.06% REIT 28.24% S&P 500 1.40% WTI 44.80% Gold 31.35% Gold 5.53% Wilshire 28.29% REIT 26.97% WTI 8.15% Wilshire 16.05% S&P 500 32.39% S&P 500 13.69% REIT 1.30% Wilshire 13.40% US Treasury 7.31% FI Credit 0.30% S&P 500 26.46% Wilshire 17.18% REIT 7.48% S&P 500 16.00% WTI 7.32% Wilshire 12.70% FI Credit 0.85% S&P 500 12.00% FI Credit 5.96% S&P 500 -37.00% REIT 26.27% WTI 15.10% S&P 500 2.11% Gold 6.96% FI Credit 1.45% FI Credit 1.12% Wilshire 0.70% Gold 8.60% Wilshire 5.61% Wilshire -37.23% Gold 23.96% S&P 500 15.06% FI Credit 1.75% FI Credit 3.69% REIT 1.26% US Treasury 0.63% US Treasury 0.56% REIT 7.10% S&P 500 5.49% REIT -39.05% FI Credit 11.59% FI Credit 4.15% US Treasury 1.55% US Treasury 0.43% US Treasury 0.36% Gold -1.51% US Gold -10.50% FI Credit 2.38% REIT -17.84% WTI -53.52% US Treasury 0.80% US Treasury 2.40% Wilshire 0.98% WTI -7.08% Gold -28.26% WTI -45.76% WTI -30.50% US Treasury 0.89% Assetclassreturns 19
  20. 20. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Credit cycle: Fundamentals remains resilient  While leverage remains near historic lows, operating margin across the corporate sector has been declining since peaking in late 2014.  For larger and higher-quality companies, however, operating margin has stabilized and is even ticking up slightly. 20 S&P 100 universeS&P 500 universe Source: Bloomberg. 20.0 25.0 30.0 35.0 40.0 45.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 Percent Percent Operating margin (LHS) Total debt to total asset (RHS) 20.0 25.0 30.0 35.0 40.0 45.0 7.0 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 Percent Percent Operating margin (LHS) Total debt to total asset (RHS)
  21. 21. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Credit cycle: Sector breakdown  Across all corporate sectors, credit metrics showed little change sequentially from the previous quarter. S&P 500 debt to assets by sector S&P 500 operating margin by sector Source: Bloomberg, operating margin trailing 12 months data. 21 0 10 20 30 40 50 Energy Materials Industrials Consumer discretionary Consumer staples Health care Financials Information technology Telecom services Utilities September 2016 December 2016 -15 -5 5 15 25 Energy Materials Industrials Consumer discretionary Consumer staples Health care Financials Information technology Telecom services Utilities September 2016 December 2016
  22. 22. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Continued cost-cutting efforts have increased the likelihood of cash flow neutrality in 2017 if oil prices further stabilize. Shareholder value remains a priority for most –– however, capping potential credit upside. Maintaining current production levels and following through on targeted levels of asset sales will be key. Margin expansion in developed markets is supplementing slower growth in emerging markets as free cash flow generation remains steady. Excessive shareholder spending remains a credit challenge, as does the change in consumer sentiment to established brands. Consolidation has helped profitability. Credit will remain largely stable. YTD sector performance and outlook: Tightening spreads Materials sector 22 Fundamentals improve in the metal/mining sector due to the recovery in commodity prices, ongoing defensive balance sheet repair and China stimulus efforts. In the chemical sector, portfolio optimization, bolt-on acquisitions and cost-cutting efforts continue amid low organic growth prospects and low interest rates. Solid employment levels will continue to drive consumption growth, especially for travel and leisure services. Home improvement sales benefit from housing market gains, while general retail is exposed to a shift in consumer preference, which has shrunk growth. Energy sector Consumer discretionary sector Consumer staples sector 0 50 100 150 200 250 300 350 400 Investment grade CDS IG materials OAS 0 100 200 300 400 500 Investment grade CDS IG energy OAS 0 50 100 150 200 250 Investment grade CDS IG cons. disc. OAS 0 20 40 60 80 100 120 140 160 180 Investment grade CDS IG cons. staples OAS
  23. 23. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Cloud computing –– which the industry is increasingly betting its future on –– shows robust growth, but overall revenue growth remains challenging with global economic growth lukewarm at best. Though many maintain net cash positions, continued shareholder spending is driving up leverage and remains a key risk –– as does M&A. Profitability is improving, albeit at a measured pace, as net interest margin benefits from rising interest rates and cost-cutting. Fundamentals are stable as capital levels, liquidity and asset quality remain solid. Regulatory and compliance costs are likely to remain high in the near term as the future of the regulatory environment remains uncertain. YTD sector performance and outlook: Tightening spreads Healthcare sector 23 Industry consolidation will continue, though the pace of large, transformative transactions will slow compared to recent years. Relatively smaller transactions, particularly in biotech, will continue to grow. International markets remain growth avenues, though developed economies remain the focus of core profitability. The outlook is for modest global demand with divergence in key end markets. Defense, healthcare and aerospace continue expanding, while agriculture, construction and energy may stabilize. Event risk remains elevated with M&A and shareholder spending amid the backdrop of lackluster growth since many have balance sheet capacity to finance deals. Technology sector Industrials sector Financials sector 0 50 100 150 200 Investment grade CDS IG healthCare OAS 0 50 100 150 200 Investment grade CDS IG technology OAS 0 20 40 60 80 100 120 140 160 180 Investment grade CDS IG industrial OAS 0 50 100 150 200 Investment grade CDS IG financials snr OAS
  24. 24. Global economy
  25. 25. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Canada: Handling risk Household debt risingInflating home prices Banks adequately fortified  Housing is booming. Vulnerabilities from rising home prices were cushioned by down payment requirements, strong underwriting and the recourse nature of many mortgages.  Steady growth in auto loans and credit card debt along with larger mortgages has increased the debt load of a typical Canadian household. However, low interest rates have softened the increased burden of debt servicing.  Canada’s banking system remains sound as many banks have the capacity to internally generate ample capital, which has generally been rising. Losses remain relatively low. Sources: Terranet and National Bank, Statistics Canada, bank annual reports, Bloomberg, SVB Asset Management. 25 12 12.5 13 13.5 14 14.5 15 120 125 130 135 140 145 150 155 160 165 170 DebtServiceRatio,% Debttodisposaleincome,% Debt to disposable income Debt service ratio 22 24 26 28 30 32 34 8 8.5 9 9.5 10 10.5 11 2012 2013 2014 2015 2016 Chargeoff,basispoints Tier1CommonEquityRatio Basel III Tier 1 Common Equity Ratio (SVB Canada bank index) Charge-off ratio (SVB Canada bank index) 95 115 135 155 175 195 June2005=100 Teranet-National Bank Home Price Index Composite 11
  26. 26. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Australia: Expansion intact Job market OKSteady growth Retail sales still growing 26 Source: Australia Bureau of Statistics,Dow Jones VentureSource, National Bureau of Statistics of China, Bloomberg, SVB Asset Management.  Australia maintained growth in commodity prices through the downturn, with GDP growth within the 2-3 percent range. Though the currency has nominally weakened, falling inflation may provide the Reserve Bank of Australia with scope to ease, which would provide macroeconomic expansion support.  The labor market improved through the course of year, with unemployment at the lowest levels since 2013. Even though part-time jobs underpinned the improvement, and wages and hours worked remain weak, the higher employment levels have contributed to domestic demand.  Retail sales have drifted lower recently, but still remain economically supportive. Consumer spending may be stronger than indicated, since weak sales at department stores, as well as of clothing and shoes, may be due to shifting preferences for leisure services and digital spending. 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 0 0.5 1 1.5 2 2.5 3 3.5 CPI,%changeyearoveryear GDP,%changeyearoveryear RBA CPI trimmed mean core CPI Real GDP 5.2 5.4 5.6 5.8 6 6.2 6.4 %unemployment Last price 0 1 2 3 4 5 6 7 %change,yearoveryear Retail sales
  27. 27. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Nordics: Stability endures Sweden: Powering aheadNorway: More fiscal stimulus on the way Denmark: Rebounding domestic consumption  Norway is utilizing its sovereign wealth fund to aid the economy, which has been dragged by low oil prices over the past two years. While GDP showed recent contraction, the economy is expected to post positive, albeit low, growth overall for 2016 and 2017, helped by government spending and a stable unemployment rate.  Economic activity remains solidly positive in Sweden, with manufacturing experiencing a recent uptick. Employment conditions remain good and consumer confidence is solid. This favorable environment is underpinned by the loose monetary policy of the central bank.  Denmark’s domestic demand remains in growth mode despite a recent softening. Household consumption helped drive an economic rebound over the past year, with spending on autos, housing and services increasing at a good pace. Source: China Federation of Logistics and Purchasing, Dow Jones VentureSource, National Bureau of Statistics of China, Bloomberg, SVB Asset Management. 27 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 %change,yearoveryear GDP central government spending 44 46 48 50 52 54 56 58 60 PMIindex:>50=expansion Swedbank manufacturing PMI -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 Finalconsumptionexpenditure, %changeyearoveryear
  28. 28. Portfolio management strategy
  29. 29. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Portfolio strategy: Macro overview Source: SVB Asset Management and Bloomberg. Data as of 12/30/16. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio. Economy Rates Duration Sector Stable data • Q3 2016 GDP: +3.5% (two-year high) • Unemployment rate: +4.6% (nine-year low) • Weekly jobless claims 2016 average: 263,000 –– below 300,000 since March 2015 • Inflation rising towards Fed targeted level Moderate steepening in yield curve • 18-month Treasuries yielding 1.03% • 24-month Treasuries yielding 1.19% • The two-year yield pickup over 18 months has averaged 0 to +9 basis points for most of 2016 • Post U.S. presidential election, the yield pickup has risen above +15 basis points Defensive • Short and intermediate benchmarks: long duration versus benchmark as coupon income should offset price volatility • Intermediate plus benchmarks: stay neutral to benchmark • Long benchmarks: shorter to manage price fluctuations and maximize reinvestment opportunities Overweight spread product • Favor corporate bond, commercial paper and asset-backed securities • Diversify by security type, sector and issuer concentration • As rates rise, spread product will help protect bond prices due to higher income accruals 29
  30. 30. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Portfolio strategy: Credit risk management Key criteria for approved issuers 1. Strong franchise value 2. Diversified business lines 3. Strong balance sheet 4. Healthy cash flow generation 5. Strong liquidity profile 6. Robust capital to absorb downturns 7. Management with solid track record 8. Prudent financial policy 9. Quality and timeliness of the disclosure 10. Strong collateral performance and sponsor’s interest alignment for asset backed securities  We are highly selective in our security selection process and look to diversify by sector, sub-sector and issuer concentration.  Our dedicated credit research team performs a rigorous examination of every issuer and ongoing credit monitoring of all investments.  Our credit analysis incorporates a proprietary scoring system to analyze issuers, and takes into account trading factors such as market liquidity, market depth and headline risk. 30 S&P Moody's Fitch Rating description AAA Aaa AAA Highest credit quality AA+ Aa1 AA+ High credit qualityAA Aa2 AA AA– Aa3 AA– A+ A1 A+ Upper-medium gradeA A2 A A– A3 A– BBB+ Baa1 BBB+ Medium gradeBBB Baa2 BBB BBB- Baa3 BBB- Investment grade Source: SVB Asset Management and Bloomberg. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio.
  31. 31. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 0.50 0.38 0.25 0.13 0.00 -0.13 -0.25 -0.38 -0.50-0.6 -0.4 -0.2 0.0 0.2 0.4 0.6 Percent -100 -75 -50 -25 Base case +25 +50 +75 +100 % in market value Short duration 3 month T-bill Short duration 3-6 month T-bill Intermediate duration 6 month T-bill Intermediate plus duration 9 month T-bill Long duration 1 year Treasury Benchmark duration 0.25 0.375 0.50 0.75 1.0 Portfolio duration target Portfolio strategy: Interest rate risk management Source: SVB Asset Management and Bloomberg. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio as individual portfolio durations will vary. Duration (price sensitivity) analysis  We exercise a disciplined benchmarking approach to manage portfolio duration –– positioning duration in a +/- 30% band around the appropriate benchmark.  In a rising-rate environment, where a portfolio is more susceptible to unrealized losses, we mitigate this risk by managing average duration relative to the benchmark and limiting exposure to longer-dated investments. This allows for greater reinvestment opportunity to take advantage of higher anticipated rates. *Example of portfolio with duration of 0.5 years 31 -30% Neutral +30% -30% Neutral +30% -30% Neutral +30% -30% Neutral +30% Neutral-30% +30%
  32. 32. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Portfolio Strategy Relative value curve analysis  In Q4, Treasury yields backed up across the curve  Attractive opportunities in the front end with 9th month Treasury yields offering 18 basis points of yield pickup for an additional three months Front-end Treasury yield curve 32 Source: SVB Asset Management and Bloomberg. Data as of 12/30/2016. Past performance is not a guarantee of future results. The above is not to be construed as a recommendation for your particular portfolio. Treasury CP ABS AA Ind A- Ind AA Fin A- Fin 90D 0.50 0.80 1.00 0.77 1.05 0.94 1.17 180D 0.62 1.10 1.08 0.91 1.18 1.04 1.36 270D 0.80 1.25 1.17 1.03 1.24 1.23 1.46 1Y 0.91 1.28 1.06 1.31 1.29 1.60 1.5Y 1.03 1.47 1.29 1.56 1.58 1.76 2Y 1.19 1.65 1.39 1.77 1.72 1.91 2.5Y 1.30 1.81 1.65 1.88 1.98 2.12 3Y 1.45 1.97 1.74 2.06 2.08 2.22 Commercial paper 180 day CP yield is between 1.5 and 2 year Treasury Asset-backed securities ABS provide high credit quality and price stability AA finance AA finance yields offer over 25 basis points yield pickup over AA industrials 0.27 0.45 0.58 0.65 0.73 0.76 0.84 0.87 0.50 0.62 0.80 0.91 1.03 1.19 1.30 1.45 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 Percent 9/30/2016 12/30/2016 +18bp yield pickup
  33. 33. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 Our team Portfolio Management Team Eric Souza esouza@svb.com Paula Solanes psolanes@svb.com Renuka Kumar, CFA rkumar@svb.com Jose Sevilla jsevilla@svb.com Hiroshi Ikemoto hikemoto@svb.com Jason Graveley jgraveley@svb.com President, SVB Asset Management Lauri Moss lmoss@svb.com Head of Investment Strategy and Portfolio Management Ninh Chung nchung@svb.com Head of Credit Research Melina Hadiwono, CFA mhadiwono@svb.com Credit and Risk Tim Lee, CFA tlee@svb.com Daeyoung Choi, CFA dchoi@svb.com Nilani Murthy nmurthy@svb.com Silicon Valley Bank Partners Teresa Quizon tquizon@svb.com 33
  34. 34. SVB Asset Management | Quarterly Economic Report Q1 20170117-0005GUEXP0517 This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice, nor is it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction. All material presented, unless specifically indicated otherwise, is under copyright to SVB Asset Management and its affiliates and is for informational purposes only. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party without the prior express written permission of SVB Asset Management. All trademarks, service marks and logos used in this material are trademarks or service marks or registered trademarks of SVB Financial Group or one of its affiliates or other entities. ©2017 SVB Financial Group. All rights reserved. Silicon Valley Bank is a member of the FDIC and the Federal Reserve System. Silicon Valley Bank is the California bank subsidiary of SVB Financial Group (Nasdaq: SIVB). SVB, SVB FINANCIAL GROUP, SILICON VALLEY BANK, MAKE NEXT HAPPEN NOW and the chevron device are trademarks of SVB Financial Group, used under license. B_SAM-16-15210 Rev 01-24-17. SVB Asset Management, a registered investment advisor, is a non-bank affiliate of Silicon Valley Bank and member of SVB Financial Group. Products offered by SVB Asset Management: Are not insured by the FDIC or any other federal government agency Are not deposits of or guaranteed by a bank May lose value 34

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