SITUATION ANALYSIS

U.S. Equities Quarterly Update Executive summary

Performance review

On balance, the first quarter ended with oil, the Federal Reserve (Fed) and earnings — which all serve as primary factors impacting equity returns — being less of an immediate concern, thus serving as the basis for equities to post strong returns in March.

• Market and sector performance. Equity performance in the first quarter was varied, volatile yet remarkably resilient, thanks to strong performance in March.

• Oil appears to be stabilizing, helping to bolster investor sentiment and equity returns. • The Fed’s decision in March to leave short-term interest rates unchanged has been a near-term positive for equities, helping to reduce policy risk associated with raising rates prematurely. We expect the Fed to raise rates two times in 2016, beginning in June. • First quarter earnings reports, scheduled for release in mid-April, may serve as a key upcoming catalyst for equities. Consensus estimates for 2016 continue to trend lower. Higher earnings are required to help support higher stock prices. • Our published 2016 year-end price target for the S&P 500 is 2,050, which is essentially where the popular index ended the quarter. While our bias is to the upside, we intend to review our assumptions, estimates and price target midway through the first quarter earnings season, following quarterly releases and updated company guidance.

Equities ended the quarter with international emerging markets outpacing international developed and U.S. stocks, large-cap companies outperforming small-cap companies and defensive sectors generally performing better than cyclicals. The strong March performance is perhaps what is most noteworthy about overall performance in the first quarter. The broad-based favorable returns in March among international, domestic, large- and small-cap indices, as well as cyclical and defensive sectors are typically “risk-on” indicators, supportive of advancing equity prices. Market and sector performance Price

Index

3/31/2016

2015

S&P 500 Dow Jones Industrials Russell 2000 MSCI EAFE MSCI Emerging Markets

2,059.74 17,685.09 1,114.03 1,652.04 836.80

-0.7% -2.2% -5.7% -1.9% -14.9%

20.8% 15.6% 14.3% 12.9% 6.8% 10.4% 10.1% 2.8% 3.5% 2.8%

4.3% -3.5% 5.2% 8.4% -23.6% 3.8% -4.7% -10.4% -8.4% -1.7%

2016 March YTD 6.6% 0.8% 7.1% 1.5% 7.7% -1.9% 6.0% -3.7% 13.0% 5.4%

Sectors of the S&P 500 Information Technology Financials Healthcare Consumer Discretionary Energy Consumer Staples Industrials Materials Utilities Telecommunication Services

9.1% 7.1% 2.6% 6.5% 9.2% 4.3% 7.0% 7.4% 7.7% 6.3%

2.2% -5.6% -5.9% 1.2% 3.1% 4.9% 4.3% 3.0% 14.5% 15.1%

Source: FactSet Research Systems. Data: 3/31/16; excludes dividends.

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SITUATION ANALYSIS U.S. Equities Quarterly Update– continued

• Technical repair. Volatility was a common characteristic of equity performance throughout the first quarter, particularly in January and February, evidenced by the S&P 500 Index trading between high/low levels of 2,063 and 1,829, before ending the quarter toward the high end of the trading range. While technical trends are widely considered to be under repair, the S&P 500 has rallied as of the end of the quarter to levels that many technicians deem to be approaching near-overbought levels, with technical resistance and perhaps some selling pressure likely to occur around the 2,075 level. 2200

50-day moving average

S&P 500 Index price level

2100

S&P 500 price

2050 2000 1950 1900 1850 1800

200-day moving average

1750 1700

Apr 2014

Jul 2014

Oct 2014

Jan 2015

Apr 2015

Jul 2015

Source: FactSet Research Systems. Data as of 3/7/16.

[ 2 ]  Important disclosures provided on page 8.

Oct 2015

Jan 2016

• Factors impacting equity prices. The macro and fundamental backdrops, in our view, remain largely supportive of equity prices. Risks appear to be elevated. The slow pace of global growth, implications of low oil prices, the slowing in the rate of economic growth in China, uncertainty surrounding the pace of rate hikes and election-year dynamics are among items or concerns impacting investor sentiment and equity returns. The checklist of items that typically reflect a market top, however, appear balanced and generally supportive of a buy-the-dips, grind-higher outlook.

S&P 500 two-year trading range 2150

Economic back drop

Mar 2016

The economic scorecard remains favorable. While manufacturing and retail sales levels remain sluggish, modest economic growth, restrained inflation, solid employment trends, firming wages, stable housing and still-low interest rates present a favorable backdrop for equities. Admittedly, valuations are toward the high side of fair. Yet, in the absence of inflation, we see valuations remaining near current levels. Ramping inflation toward the 4 percent level, which we do not expect for the foreseeable future, has historically been the level at which multiple contraction accelerates.

SITUATION ANALYSIS U.S. Equities Quarterly Update– continued

Factors impacting equity price trends Risks are elevated

Economic scorecard Growth Inflation Employment Wage gains Housing Interest rates Valuation Retail sales Sentiment / confidence Manufacturing

• Pace of global growth • Oil • China • Geopolitical tensions • Earnings uncertainty • Fed • Election-year dynamics

Market top checklist Blow-off top (animal spirits) Heavy fund inflows into equities Inflationary fears Rising interest rates Shift toward defensive leadership Big pick-up in M&A activity Large-cap outperforming small-caps Weakening EPS revisions Fewer stocks making new highs Credit spreads widening

Rebounding Restrained Solid Firming Stable Low Fair Mixed Mixed Soft

Swing factors No No No No Some Some Yes Yes Yes Yes

• Revenue / earnings growth • Stabilizing oil prices • China and pace of economic growth • U.S. dollar • Fed and pace of future rate hikes

Source: U.S. Bank Wealth Management Strategic Equity Group.

• Few signs of a looming recession. Current conditions appear inconsistent with those of past recessionary periods. While manufacturing remains sluggish, there is limited evidence of a pending slowdown in U.S. growth. Admittedly, negative interest rate policies around the world, including the potential for implementation of a negative interest rate policy in the United States, introduce the possibility that conditions this time could be different.

Recessionary indicator scorecard Start of recession Dec 1969

Yield curve ✖

ISM mfg. ✖

Inflation Capacity Housing trends utilization starts ✖ ✖ ✖

Nov 1973

✖

✖

Jan 1980

✖

✖

Jul 1981

✖

✖

Jul 1990

✖

✖

✖

Mar 2001

✖

✖

✖

Dec 2007

✖

✖

Jun 2015

✔

Present

✔

✖

Labor market ✖

✖

✖

✖

✖

✖

✖

✔

✔

✖

✔

✖

✖

✖

✖

––

✖

✖

✖

✖

––

✔

✔

––

✔

✔

––

✔

––

✔

✔

✖ Recessionary territory

✔ Expansionary territory

✖

– – Neutral

Sources: Standard & Poor’s, National Bureau of Economic Research, Federal Reserve, Bureau of Labor Statistics, Institute for Supply Management, Census Bureau, Haver Analytics, RBC Capital Markets.

[ 3 ]  Important disclosures provided on page 8.

SITUATION ANALYSIS U.S. Equities Quarterly Update– continued

Additionally, seldom do recessions occur without the yield curve first inverting, as illustrated in the accompanying graph. Of course, central bank intervention, both home and abroad, has been unprecedented, making past yield curve comparisons potentially misguided. Yield curve as a recession indicator 5%

Maximum historical spread

4% 3%

Yield

2% Average spread 1.5

1% 0%

While the gap between oil supply and demand remains wide, this imbalance is projected to narrow in 2017. – Of ongoing debate is the extent to which an expected decline in U.S. shale production is likely to be offset by increased production in the Gulf of Mexico and OPEC countries, such as Iran, effectively keeping the production/consumption imbalance intact. – Relatedly, it seems plausible that the production/ consumption imbalance can become prolonged if production ramps as a result of the recent price uptrend. In this sense, the recent increase in oil prices may be somewhat self-defeating over the intermediate term. World liquid fuels production and consumption balance

-1% -2% 1979

1984

1989

1994

1999

2004

2009

2015

Sources: Federal Reserve, Haver Analytics, RBC Capital Markets.

• Impact of oil. Much of the broad equity market volatility throughout the first quarter was associated with the price swings of oil. Significant disruptions, ranging from capital expenditures to employment, can be expected anytime a commodity, such as crude oil, gets cut in half over the course of a year.

Price per barrel

4Q14 72.94

$65

1Q15 48.72

1Q16 32.25 -33.8% YoY

Jan 2015

Apr 2015

Jul 2015

Oct 2015

Jan 2016

Mar 2016

Sources: U.S. Energy Information Administration (EIA), Bloomberg, RBC Capital Markets. Data: average over the quarter.

[ 4 ]  Important disclosures provided on page 8.

World production

96 94 92

5 4 3

World consumption

2

90

1

88

0

86

-1

84

-2

82

1Q 2011

-3 1Q 2012

1Q 2013

1Q 2014

1Q 2015

1Q 2016

1Q 2017

The global breakeven costs of production vary by region and basin. Production costs continue to trend downward and Saudi Arabia is widely considered to be the low-cost global producer while producers in South America, such as Venezuela, are among the highest-cost producers.

4Q15 42.11 -42.3% YoY

$45

$25 Oct 2014

98

6

Source: U.S. Energy Information Administration, Short-term Energy Outlook; data through 1/31/16.

Oil prices (2-year trend) $85

World production, world consumption (million barrels per day)

1974

Projections

Implied stock change and balance (million barrels per day)

-3% 1969

100

SITUATION ANALYSIS U.S. Equities Quarterly Update– continued

imbalance is about to narrow. While still early, items that could contribute to this rebalance include:

Global breakeven cost stack

U.S. tight oil

Price per barrel (in USD)

$120 $110 $100 $90 $80 $70 $60 $50 $40 $30 $20 $10 $0

Bakken average Other OPEC onshore and shallow Other NGLs U.S. NGLs Middle East OPEC

0

Conventional onshore and shallow water non-OPEC

– Further decline in U.S. production GTL/CTL Venezuela extra heavy Oil sands mining Oil sands insitu Global ethanol Deepwater

Middle East non-OPEC

10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 90,000 100,000 Global liquids supply (millions of barrels per day)

Source: IHS, Inc. Data: 2014.

As an overview, energy companies operate within upstream, midstream and downstream segments of the value chain. Upstream represents oilfield services, exploration and production companies. Among midstream and downstream companies are pipelines, refiners and retail outlets. With the current production/consumption imbalance, in our view, mid to downstream companies may offer attractive risk/reward profiles. Oil and gas value chain Upstream

Midstream

Downstream

– Decline in OPEC and non-OPEC production – Further coordination of production levels among OPEC countries – Increase in demand • Federal Reserve. Expectations have largely shifted toward a June rate hike. The Federal Open Market Committee’s (FOMC) decision in March to leave shortterm interest rates unchanged has been a near-term positive for equity prices. While the decision to leave interest rates unchanged was widely anticipated, Fed officials ended the quarter by backtracking from the dovish tone set forth following the March meeting. Deferring a rate hike until June reduces near-term fears of policy risk associated with raising rates prematurely. And, delaying the rate hike potentially lessens the drag on earnings associated with a rising dollar over the next couple of quarters. Importantly, in our view, the U.S. economy has improved to levels warranting something other than crisis-level rates. That said, we also expect the glide path toward higher rates to be deliberate. Our current expectation is for the Fed to raise rates two times in 2016, beginning in June. Schedule of 2016 remaining FOMC meetings

April 26-27 Oilfield services + equipment

Independents (E&P)

Integrateds

Petrochemicals Pipelines, LNG storage Refineries

Source: FactSet Research Systems. Data: Relative shares of market value in 2015 (total market value approximately $3.2 trillion).

The price of West Texas Intermediate (WTI) crude oil ended the first quarter around $38 per barrel, up over 50 percent from February lows of around $26 per barrel and over expectations that the production/consumption

[ 5 ]  Important disclosures provided on page 8.

June 14-15* July 26-27 September 20-21* November 1-2 December 13-14* Source: Federal Reserve. *Meetings include Summary of Economic Projections (SEP) and press conference.

SITUATION ANALYSIS U.S. Equities Quarterly Update– continued

• Earnings and valuation. First quarter earnings, scheduled for release in mid-April, are a key upcoming catalyst for equities. Ultimately, in an earnings-driven market, an improving economy is needed to drive earnings, and higher earnings are required to support higher stock prices. The S&P 500 ended the first quarter with valuations toward the high side of fair, on the heels of consensus 2016 estimates that generally were being reset lower as the quarter progressed. The S&P 500 ended the first quarter trading at 18.7 and 17.4 times consensus trailing 12-month and 2016 estimates, respectively, which is modestly above historical averages.

The percent of S&P 500 companies beating revenue estimates has declined in recent quarters, a headwind for earnings growth. Stabilizing revenue growth is important because opportunities for margin expansion become increasingly difficult to be gleaned in an environment of firming wages and higher interest rates. 80%

S&P 500 companies beating quarterly revenue estimates

70% Average

60% 50%

46%

S&P 500 P/E with long-term average 30x

40%

P/E multiple

25x

30% 2002

20x

2006

2008

2010

2012

Source: Strategas Research Partners. Data: through 4Q 2015. Average

15x 10x

5x 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Feb 2016

Source: Strategas Research Partners. Data: trailing 12-month basis through 2/22/16. P/E: price/earnings.

2014

4Q 2015

• Margin debt. Margin debt remains high, partially spurred by low borrowing costs, as illustrated in the NYSE investor credit and market graph. Of question is what happens to equity price trends when interest rates eventually move up and margin debt becomes more expensive. At a minimum, we expect future volatility to increase as expectations shift toward a rising rate environment.

Consensus S&P 500 2016 EPS estimates $150

$250

Credit balances vs. stock market

2500

$200

$140 $135 $130 $125 $120

2000

$150 $100

1500

$50 $0

1000

-$50 -$100 -$150

Current level

500

-$200

Aug 2014

Dec 2014

Apr 2015

Aug 2015

Source: Strategas Research Partners. Data: through 1/31/16. EPS: earnings per share.

[ 6 ]  Important disclosures provided on page 8.

Dec 2015

Jan 2016

-$250 1980 1985 1990 1995 Positive investor credit balances Negative investor credit balances

0 Jan 2016 S&P 500 Index monthly closing level

2000

2005

Source: dshort.com website. Data: February 2016.

2010

S&P 500 Index price level

Credit balance (shown in billions)

$145

$115 Apr 2014

2004

SITUATION ANALYSIS U.S. Equities Quarterly Update– continued Sector highlights • Biased toward growth. We continue to favor sectors and companies that tend to perform well in a slowgrowth, low-inflation global environment. – On balance, we favor companies growing revenue faster than peers and operating in markets growing faster than the economy. – Companies that cater to a global consumer, ecommerce, cloud computing, anytime anywhere connectivity and an aging population tend to have

attractive revenue growth profiles in an otherwise uncertain and slow-growing global environment. – Throughout the first quarter, value-oriented sectors and companies returned to favor, partially due to trough valuations and dividend appeal. – In aggregate, we continue to advocate a barbell approach, favoring both select growth and value names, with unique characteristics and competitive advantages.

Sector insights and preferences S&P 500 sector

Index Recommended weight emphasis

Rationale

Consumer Discretionary

12.9%

Overweight

Firming wages, low energy prices and rising consumer net worth are among reasons to expect rising levels of consumer spending in 2016. The eventual rise in oil prices and propensity for consumers to save are among concerns. Sector has favorable EPS growth prospects.

Consumer Staples

10.4%

Underweight

A defensive sector. Lackluster global growth dynamics favor staples as an attractive placeholder amidst global uncertainty. Stocks appear expensive, particularly given sluggish same-store sales data.

6.8%

Underweight

Remains a wildcard due to the global supply/demand imbalance and overall price volatility. Sentiment appears to be improving. A move up in oil prices could be self-defecting, as it could prolong the production/consumption imbalance. Favor pipelines and refiners.

Financials

15.6%

Market Weight

Regulatory pressures and technology are transforming the nature of the industry. Balance sheet improvement and expectations for improving loan growth and net interest margins are partially offset by a flattening yield curve and recessionary concerns.

Healthcare

14.3%

Overweight

Favor companies at the forefront of innovation (neurology, oncology, immunology), leaders in emerging markets, and growing sales and profits by reducing overall healthcare inflation. Debate over drug pricing is a headwind. Sector has both growth and defensive characteristics.

Market Weight

Falling crude oil prices and slow global growth weighed on performance in 2015. Manufacturing has been soft. The risk/reward is intriguing given improving U.S. economic data, strong cash flows, attractive dividends, reasonable valuations and declining U.S. dollar. Low capital expenditure levels remain a negative.

20.8%

Overweight

A pro-growth sector, with many sources of innovation. Beneficiary of increasing capital expenditure. Many companies within the sector are demonstrating strong free cash flow, mounting cash levels, with attractive dividend growth potential. Biased toward companies with pricing power and defensive growth.

Materials

2.8%

Market Weight

An eclectic sector, with wide-ranging company platforms. Biased toward commodityusing vs. commodity-producing companies. The economic landscape in China and other emerging markets’ metals-consuming economies are wildcards.

Telecommunication Services

2.8%

Underweight

Easing of competitive pricing pressures and attractive yields are positives. Growth seems limited given market saturation and industry maturity. High payout ratios limit the ability to increase dividends and bond-like characterics suggest caution. Defensive characteristics are positives.

Utilities

3.5%

Underweight

Valuations appear elevated, partly the result of investors searching for yield and as a safehaven given global uncertainty and market volatility. Inherent bond-proxy characteristics suggest underperformance when interest rates rebound. Defensive, strong-performing sector YTD.

Energy

Industrials

Information Technology

10.1%

Source: U.S. Bank Strategic Equity Group.

[ 7 ]  Important disclosures provided on page 8.

SITUATION ANALYSIS U.S. Equities Quarterly Update– continued

Conclusions Investors ended the first quarter at the crossroads of concern and optimism, with a bias toward optimism since many of the issues that have plagued sentiment and overall equity returns throughout January and February — namely oil, the Fed and earnings — appear to be less of an immediate concern. • Oil appears to be stabilizing, evidenced by the price of WTI crude closing the quarter around $38 per barrel. While we expect the price of oil to remain volitile in 2016, the rally from below $30 per barrel in February has helped bolster investor sentiment and lessen immediate concerns of additional stress to energy-related companies with financial constraints.

performance of equities in the quarter. We expect first quarter results and company guidance to set the tone for performance into midyear. • First quarter earnings remain a key catalyst for equity performance in the second quarter. • Our published 2016 year-end price target for the S&P 500 is 2,050, essentially where the popular index ended the quarter. The near-term risk/reward profile of equities appears balanced. While our bias is to the upside, lack of accelerating earnings growth is among the list of reasons that give us pause. We anticipate reviewing our assumptions, estimates and price target midway through first quarter earnings season, following quarterly releases and updated guidance.

• The Fed’s decision to leave short-term interest rates unchanged in March was a near-term positive for equities and was a key contributor to the favorable

This commentary was prepared April 1, 2016 and the views are subject to change at any time based on market or other conditions. This information represents the opinion of U.S. Bank Wealth Management and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not affiliated or associated with any organizations mentioned. Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded blue chip stocks and is the most widely used indicator of the overall condition of the U.S. stock market. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index and is representative of the U.S. small capitalization securities market. The MSCI EAFE Index includes approximately 1,000 companies representing the stock markets of 21 countries in Europe, Australasia and the Far East (EAFE). The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. The value of large-capitalization stocks will rise and fall in response to the activities of the company that issued them, general market conditions and/or economic conditions. Stocks of small-capitalization companies involve substantial risk. These stocks historically have experienced greater price volatility than stocks of larger companies and may be expected to do so in the future. Investments in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in fixed income securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. © 2016 U.S. Bank (4/16)

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