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Asset Allocation Committee Outlook

Fourth Quarter 2014

Broken Records: New Highs for U.S. Stocks, New Lows for European Interest Rates and Implications for the Future

  • Preference for equities over fixed income intact—with caveats
  • Slight upward adjustments for U.S. all cap and large cap equities and emerging markets equities
  • Developed market non-U.S. equities adjusted downward slightly

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Highlights from the 4Q14 Outlook

Erik Knutzen
Chief Investment Officer – Multi-Asset Class

 Below-Normal Return Outlook 12-month Forecast In Line with
5-7 Year Annual Return Outlook
 Above-Normal Return OutlookChange From
Previous Outlook
   o  + 
Global Fixed Income              
Bunds 10 Year              
Gilts 10 Year              
JGBs 10 Year              
U.S. Treasury 10 Year              
U.S. Investment Grade Fixed Income              
Investment Grade Corporates              
Agency MBS              
CMBS / ABS              
U.S. TIPS              
High Yield Corporates              
Emerging Markets Fixed Income              
EMD Local Sovereign              
EMD Hard Sovereign              
EMD Hard Corporates              
Return outlook higher than previous quarter
Return outlook lower than previous quarter
Return outlook essentially unchanged
 Below-Normal Return Outlook 12-month Forecast In Line with
5-7 Year Annual Return Outlook
 Above-Normal Return OutlookChange From
Previous Outlook
   o  + 
Global Equities              
U.S. Large Cap              
U.S. Small Cap              
Master Limited Partnerships              
Developed Market—Non-U.S. Equities              
Emerging Markets Equities              
Public Real Estate              
Return outlook higher than previous quarter
Return outlook lower than previous quarter
Return outlook essentially unchanged
 Below-Normal Return Outlook 12-month Forecast In Line with
5-7 Year Annual Return Outlook
 Above-Normal Return OutlookChange From
Previous Outlook
   o  + 
Lower Volatility Hedge Funds              
Directional Hedge Funds              
Private Equity              
Return outlook higher than previous quarter
Return outlook lower than previous quarter
Return outlook essentially unchanged
 Below-Normal Return Outlook12-month Forecast In Line with
5-7 Year Annual Return Outlook
Above-Normal Return OutlookChange From Previous Outlook
Swiss Franc      
EM FX (broad basket)      
Return outlook higher than previous quarter
Return outlook lower than previous quarter
Return outlook essentially unchanged

*The currency forecasts are not against the U.S. dollar but stated against the other major currencies. As such, the forecasts should be seen as relative value forecasts and not directional U.S. dollar pair forecasts. Currency forecasts are shorter-term in nature, with a duration of 1–3 months. Regional equity and fixed income views reflect a 1-year outlook.

The third quarter of 2014 saw some remarkable market records—the S&P 500 Index broke 2000 for the first time in history even as European bond yields fell to lows never before seen in many centuries of sovereign borrowing. In one way, these extreme outcomes were related—as investors are compensated less for owning low-risk debt, future stock market earnings appear more attractive, boosting equity returns. In another sense, the rock-bottom interest rates on government bonds from Europe to the U.S. to Japan, and the low economic growth they imply, stands in stark contrast to the robust returns of equities so far this year, which have been driven primarily by decent earnings growth.

So what are investors to make of the different messages being delivered by global stock and bond markets? And what are the risks and opportunities presented as the U.S. prepares for an end to quantitative easing even as Europe and other regions seek to turn on the monetary spigots? The Asset Allocation Committee grappled with these key questions during its recent quarterly meeting on markets and asset classes.

It is clear that global central bank policy is playing a key role in setting the overall investment landscape. Even as the U.S. Federal Reserve (Fed) finishes tapering and markets assess the possibility of a first rate increase in 2015, the European Central Bank (ECB) and the Bank of Japan (BOJ) are committed to stimulus well into the future. We believe that the prospect of an extended period of low interest rates serves to extend the business cycle, which should be supportive of equity markets but with the potential to exacerbate key risks. Historically, stocks have performed well for the first part of the interest rate tightening cycle. In addition, low yields on government bonds present paltry expected returns for investors. This creates the potential for a continued “melting upward” of stocks as investors allocate to risky assets in the absence of better alternatives.

Yet the Committee recognizes the potential for significant divergence across global equity markets. The U.S. economy appears to be gaining traction and corporate earnings should continue to provide a boost to stocks. We are more cautious on Japan where investors are following the progress of “Abenomics” to see if wage growth can follow the decline in the yen and rising inflation. Despite recent volatility, we have become more constructive on emerging markets as growth stabilizes, even as valuations remain attractive.

Much of our discussion centered on continental Europe which, as the record-setting bond yields indicate, has struggled to achieve growth. As the ECB prepares to implement outright quantitative easing, we acknowledge that the region is vulnerable to a deflationary shock if monetary stimulus fails to take hold or the conflict between Ukraine and Russia intensifies.

Market levels of risk, as measured by the VIX and credit spreads, have risen in recent weeks. With countries and markets diverging, we remain watchful of challenges in one area serving as a contagion to broader global markets.

Overall, our long-term asset class preferences in favor of equities over fixed income remain intact, with the caveats mentioned above. Slight changes on the margin include an upgrade to a slightly overweight view for U.S. all cap and large cap equities as well as emerging markets equities. The Committee moderated its view on developed market non-U.S. equities, moving toward a neutral position.

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The views expressed herein are generally those of Neuberger Berman’s Asset Allocation Committee which comprises professionals across multiple disciplines, including equity and fixed income strategists and portfolio managers. The Asset Allocation Committee reviews and sets long-term asset allocation models, establishes preferred near-term tactical asset class allocations and, upon request, reviews asset allocations for large diversified mandates and makes client-specific asset allocation recommendations. The views and recommendations of the Asset Allocation Committee may not reflect the views of the firm as a whole and Neuberger Berman advisors and portfolio managers may recommend or take contrary positions to the views and recommendation of the Asset Allocation Committee. The Asset Allocation Committee views do not constitute a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events may differ significantly from those presented.

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