Quarterly Economic Outlook Q3 2016

Another Quarter, Another Surprise Welcome back to the second installment of the Sunwest Bank Quarterly Economic Outlook. We last covered Second Quarter highlights with Britain's surprise decision to exit the European Union (“EU”), negative yielding debt reaching a record $11.9 Trillion, mixed employment data and Commercial and Industrial (“C&I”) loan delinquencies having a major increase. Now we come to you with Third Quarter Highlights which includes a surprise Trump Presidential victory and U.S. interest rates increasing significantly with the 10 year up to 2.20%.

Eric Hovde Chairman, Sunwest Bank

Quarterly Economic Outlook Q3 2016

2

Q3 Highlights • • • • • • • • •

U.S. Presidential Election GDP Employment Trends Corporate Profits Earnings Forecasts Manufacturing Healthcare Inflation REITs

• • • • • • • • •

U.S. Housing Property Values Median Home Prices Multi-Family Delinquencies Vacancy Rates Chinese Money Flow into U.S. Chinese NPL Chinese Debt Negative Credit Trends

Quarterly Economic Outlook Q3 2016

3

And the 45th winner is… • Donald Trump surprises polls and is elected as the 45th President of the United States of America.

“There are 3 kinds of lies: lies, damned lies, and statistics.”

– Mark Twain

Source: FiveThirtyEight

Poll as of Oct. 8th, 2016

Quarterly Economic Outlook Q3 2016

4

GDP Positive… Thank You Soy Beans • GDP was reported on Friday, October 28th 2016 at 2.9% beating the consensus of 2.5%. This is our largest GDP growth in over 2 years due to a surge in exports and a rebound in inventory investment, which offset a slowdown in consumer spending • Almost one-third of Q3 GDP growth can be attributed to a one-time surge in soybean exports, which was caused by a spoiled harvest in Brazil and increased demand in China • A jump in inventories also contributed to 0.6% to the GDP figure while personal consumption contracted significantly from 2.88% to 1.47% from Q2 to Q3

• Growth continues to struggle to broaden out of the range

Source: BEA

Quarterly Economic Outlook Q3 2016

5

Stubborn Employment Trends • Continuing Jobless Claims decreased from 2,040,000 to 2,026,000 in October 2016

• In October the Unemployment Rate decreased to 4.9% negating to show much growth. There has been little change in workforce with the number of long-term unemployed, labor participation, and employment-population ratio changing little month-to-month • However, this continues to be driven by labor force participation declines

• The Federal Reserve’s Labor Market Conditions index has continued to decline, dropping below 0% YoY for the first time since the last recession • Of the 7 times the index fell below 0%, 5 were followed by recessions Source: Bloomberg

Quarterly Economic Outlook Q3 2016

6

Where’s the Beef? • Corporate Profits in the U.S. decreased by 1.9% to $1,477B in the second quarter of 2016

• Dividends decreased 1% or $9.3B • The economy is experiencing minimal growth with GDP less than 3% for the 8th consecutive quarter • Healthcare costs are having a dramatic increase on sponsors – many companies will take Q1 charges associated with YoY healthcare increases • Will a reduced corporate tax rate come to fruition? • Will a repatriation of capital spur U.S. investments, creating profits? Source: Wall Street Journal, Trading Economics

Quarterly Economic Outlook Q3 2016

7

Earn

ings

• In October, Goldman Sachs (“GS”) cut its S&P 500 earnings estimates for each of the next few years • EPS forecasts are now $105 (2016), $116 (2017), and $122 (2018); this is drastically lower than what was projected a year ago. Will this change with Trump as our Commander in Chief? • GS expects two key issues to drive the earnings discussion in 2017: 1) Real GDP growth will persist at roughly 2% annually continuing through 2019 and 2) S&P 500 margins are likely to increase slightly next year but remain well below the peak Goldman Sachs Oct 2016

Goldman Sachs Sept 2015

Source: Goldman Sachs

Quarterly Economic Outlook Q3 2016

8

U.S. Output? • The Manufacturing PMI measures new order growth, business growth, new exports, and output volumes. It also is an important indicator to the Manufacturing health of the economy • United States Manufacturing PMI bolstered it’s largest numbers since October 2015. US Manufacturing PMI increased to 53.2 from 51.5 in September • The U.S. averaged 53.62 from 2012 to 2016, so while the increase is great in terms of economic growth, we are still manufacturing at below average levels

Manufacturing PMI

• Most of the increase in manufacturing has come from an increase in demand for the Eastern most states in the U.S.

Source: Trading Economics, Federal Reserve

Quarterly Economic Outlook Q3 2016

Source: Tradingeconomics.com

9

Gosh is Healthcare Expensive cont. • The healthcare price surge has continued into Q3, which has seen an increase in cost since 2014 • News reports have come out in October that Obamacare will raise premiums 25% on average next year • As pointed out in our Q2 Outlook, a large component that is driving US GDP is mandatory healthcare spending courtesy of Obamacare

• Healthcare costs will impact corporate earnings and consumer budgets in 2017

Source: Bank of America Merrill Lynch, Bloomberg C

Quarterly Economic Outlook Q3 2016

10

Inflation – Highest since Oct ‘14 • Headline CPI rose from =1.1% year over year to +1.5% year over year in September • Core CPI (+2.2% year over year) is the 11th consecutive month that the figure maintained above the Fed’s 2% mandated inflation target

• Key costs keep rising for consumers (rent and gasoline saw the largest increases last month) • Wage inflation in skilled jobs is beginning to accelerate

• In the meantime excess funds at FRB are declining as funds in the system are increasing. The velocity of money will increase next

Source: Bloomberg, FRED

Quarterly Economic Outlook Q3 2016

11

Risky &Expensive Investments alt. for Treasuries • Dow Jones Equity REIT Total Return Index has seen significant price pressure since hitting an all time high during the summer, declining over 10%. During the same time period the 10YR Treasury’s yield has increased over 60% with a major movement since the U.S. Presidential Election

10 Year Treasury

REIT Index Source: Bloomberg

12

REITs Investment Dynamics • Factors causing volatility • Real estate moved from Financials Sector to its own Global Industry Classification System (GICS) sector on August 31. S&P and MSCI benchmarks did not rebalance until mid September1 • REITs as part of Financials, accounted for approximately 3% of 13% weighting, have seen overarching volatility as investor demand for ETFs tracking Financials have driven underlyings as investor sentiment shifted within the sector2 • Low yields and declining interest rates along with foreign investments continue to drive property values higher, as they are being valued as bond alternatives

• Future outlook • Short-term bear case can be made with the maturity of the credit cycle, valuations near alltime highs and long-term interest rate hike rising. However, a short-term bull case can be made with strong global demand for U.S. real estate assets, NOI growth projected of 3% in 2016 and 2%+ annual NOI growth through 20201 1 Lazard Asset Management 2 Forbes

Quarterly Economic Outlook Q3 2016

13

Moving on Up… • Existing home sales remained flat YoY in every month of Q3 • Home Prices, however, have continued to increase with September marking the 55th consecutive month for YoY home price gains • The median existing home prices for all housing types in September was $234,200, up 5.6% from $221,700 in September 2015 • Foreign money is contributing to price appreciation in specific markets • Affordability is a problem and will only become worse with higher mortgage rates

Source: Bloomberg, National Association of Realtors

Quarterly Economic Outlook Q3 2016

14

Up Up & Away • The median home value in Orange County is $664,000 as of Sept. 2016. Home values in Orange County have seen a 5.9% YoY increase • Orange County is the first county in Southern California to return to its pre-recession price peak • Issues driving up property values; low inventory of existing homes, stagnant levels of new development and an increase in foreign money Source: Wall Street Journal, Zillow, Core Logic

Quarterly Economic Outlook Q3 2016

15

It Cost What?! • Back in 2005-07 when the housing bubble was brewing, the median sales price was increasing rapidly. The change in median household income is being outpaced by the change in median home price over the past several years • The gap is being fueled by debt and dual incomes for those that are stretching for home ownership. We have seen this before…

Source: U.S. Census Bureau, PWC

Quarterly Economic Outlook Q3 2016

16

The Land of Renters • Multifamily mortgage debt outstanding is continuing to increase. Surpassing the levels during the height of the recession between 2007-2010. Q2 2016 mortgage debt outstanding for Multifamily properties stands at $1.136T which is 10% higher than YoY data that was at $1.03T • Multifamily residence market has seen the cheap price of debt, all time high rents and low home ownership. When does this change?

Source: St. Louis Fred

Quarterly Economic Outlook Q3 2016

17

Chinese Money Flow • Chinese money continues to flow into the U.S. in record amounts that we first saw in the Australian Market. Investors continue to search for the most lucrative real estate markets. Including: NYC, Los Angeles, Vancouver, and San Francisco

Source: Financial Times

Quarterly Economic Outlook Q3 2016

Note: Survey sums to more than 100 % due to multiple home purchases in different cities by the same individual source.

18

Tic Toc • Non-performing Loans (“NPLs”) in China have been on a steady incline the past 16 quarters going into Q3 of 2016. Current NPL rates reported by China Banking Regulatory Commission (CBRC) has NPL balance at 1,186 billion RMB and at a rate of 1.59%

• Chinese equity markets could potentially face higher volatility amidst indications of reduced government intervention in the financial markets going forward

Source: California Home, Market Watch

Quarterly Economic Outlook Q3 2016

19

China’s Debt Load Rising • According to the Institute of International Finance, China’s total Debt-to-GDP is fast approaching 300% • Growth of both bank assets and liabilities has been growing at a faster rate in recent years (doubling GDP growth this year) • China’s domestic liabilities is now almost $30 trillion USD (US bank liabilities is roughly half of this figure) • Estimates place bad debt somewhere in the 1520% range making China possibly the biggest credit risk facing global financial systems

Source: IFF, Bloomberg

Quarterly Economic Outlook Q3 2016

20

Negative Credit Trends Mortgage Performance

• Fitch Fundamentals Index (“FFI”) remained in negative territory during Q3, continuing a trend of five consecutive quarters of weakening credit trends • The aggregate score, which is a broad measure of credit conditions across multiple asset classes, was also negative • Slowing global growth is diving weakness in transportation, as slower trade and freight volume kept that component negative for a third straight quarter • C&I delinquencies in the U.S. continue to rise

Credit Card Performance

Corporate Default Performance

High-Yield Recoveries

Rating Actions & Outlooks Corporate EBITDA Forecast Corporate Capex Forecast

Banking System CDS Outlook Transportation Trend

Quarterly Economic Outlook Q3 2016 Source: Fitch

21

Topics on Previous Economic Forecast • US Debt Yields

• U.S. Housing Data • SF Median rent price

• Sovereign Debt

• Health-care

• Negative Yields

• GDP

• US Equities

• PPI Final Demand

• Retail Sales YoY • FRED – total business inventories in inflation • BLS Employment • Jobs added by Industry • Manufacturing Output • Case-Schillar Region Chart

Quarterly Economic Outlook Q3 2016

22

For all feedback or questions, please feel free to email us at [email protected]

Thank You!

Quarterly Economic Outlook Q3 2016

23