Weekly Market Snapshot

16 October 2017

U.S. growth: Mixed signals "There isn't a single country in the world that can achieve an open economy with strict foreign exchange controls"

– People’s Bank of China (PBoC) Governor Zhou Xiaochuan

THE WEEK IN REVIEW...

U.S. growth and the Fed: December song After the minutes of the September 19-20 meeting were released last week, financial markets behaved as if a December rate hike is all but inevitable, with the fed funds futures market pricing in over 80% odds.1

But some data, both hard and anecdotal, reflect a more nuanced picture. Consumer prices for September, ex food and energy, rose 0.1% making for a 1.7% gain year-over- year – below both the consensus view and the Fed’s oft-repeated 2% target. The monthly Job Openings and Labor Trends (JOLTS) report showed the closely-watched “quits rate”, reflecting workers leaving current employment for their next jobs, at 2.1%, a decline from levels in the past four months – a possible indicator of reduced worker optimism.

Two items not yet reflected in government data: General Motors reportedly plans to temporarily close its Detroit-Hamtramck plant for about six weeks in mid-November and to dial back production levels 20% when production resumes. Second, consumer groups and electric utilities are reporting increases in the number of households experiencing shut-offs due to unpaid bills. This past summer, for example, Texas saw over 900k homes disconnected, at least temporarily, before payment terms were re-established. Clearly, the stakes are high in some parts of the economy when it comes to continued economic growth.

Catalonia: Spanish prisoner Catalan President Carles Puigdemont declined to declare independence from the rest of Spain during his address last week to the region’s parliament – while still standing behind the results of the recent referendum. The result so far: continued pressure from Madrid to either back down decisively or to accept direct rule. Spanish debt markets reacted mildly to the speech, with spreads for 5-year German Bunds actually dropping 5 basis points to 0.59%.

China backs open trade In the run-up to this week’s 19th National Congress, People’s Bank of China (PBoC) Governor Zhou Xiaochuan’s call for economic reform, made in an interview with a leading Chinese financial magazine, was broadly in line with the prevailing ruling opinion, advocating, among other points, the wider adoption of an open economy. He identified three drivers needed to accomplish this goal: greater foreign trade and investment, a more market-oriented foreign exchange rate mechanism, and the relaxation of capital controls. How many of these will be adopted during the Congress will become clearer over the coming week.

... CHART OF THE WEEK:

Unconstrained fixed income: Much appreciated

Total return of selected bond indexes

Source: Bloomberg, as of 10/9/2017. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • When investors think about their bond allocations, the focus is often on the ability to deliver income as well as dampen volatility.
  • But just as stocks can generate useful streams of income as well as capital appreciation, bonds can generate useful capital appreciation as well as income.
  • Unconstrained fixed income managers typically look to both in their pursuit of total return, evaluating the potential appetite among investors for a given bond as well as the relative value of its coupon payments.
  • But the proportion of return contributed by each can be surprising. Consider the high yield market over the past two years. Between September 30, 2015 and September 30, 2017, the Bloomberg Barclays U.S. Corporate High Yield Bond Index rose a little over 22.7%.2
  • Of that rise, over two-thirds (15.1%) came from the coupon payments of the bonds in the index while 7.7 % came from price appreciation of those bonds.
  • Similar math applies to other closely-followed bond indexes for the period. For the U.S. Investment-grade Corporate Index, the total return of 11.0% is includes a coupon return of 8.3% and price return of 2.7%; for Emerging Markets, price return was 7.2%, coupon return was 12.1%, for a total return of 19.3%.
  • Here’s where it gets more interesting: as the chart shows, U.S. high-yield bond returns struggled right after 9/30/2015, not turning the corner until February 12, the following year.
  • But between that date and September 30, high-yield bonds had a very strong total return of 31.4%: 13.0% was derived from coupons, and 18.4% from price appreciation.
  • So, two key lessons here: reinvesting coupon income can be a major part of return, even in today’s low-yield environment.
  • Second, entry points are critical for investors seeking to capture the kind of strong price appreciation seen in the high yield example above.
  • That’s a huge focus for experienced active bond managers who must be ready to dive in, whether on a sector or security level, to position themselves for swings in value can add significantly to returns – even over time periods as small as two years.

The chart:

  • The chart shows the total return, between September 30, 2015 and September 30, 2017, for 5 Bloomberg Barclays bond indexes: U.S. Aggregate, U.S. Corporate High Yield, U.S. Corporate, Global Aggregate (US dollar) and Emerging Market U.S. dollar.

2 Source for all data is Bloomberg .

Note: Dividends represent past performance and there is no guarantee they will continue to be paid.


DEFINITIONS:

Coupon is the periodic interest payment made to the bondholders during the life of the bond.

The Bloomberg Barclays U.S. Aggregate Index is a broad-based bond index comprised of government, corporate, mortgage and asset-backed issues, rated investment grade or higher, and having at least one year to maturity.

The Bloomberg Barclays U.S. Corporate Investment Grade Index is an unmanaged index consisting of publicly issued US Corporate and specified foreign debentures and secured notes that are rated investment grade (Baa3/BBB- or higher) by at least two ratings agencies, have at least one year to final maturity and have at least $250 million par amount outstanding. To qualify, bonds must be SEC-registered.

The Bloomberg Barclays EM USD Aggregate Index is a broad-based index of Emerging Market (EM) U.S. dollar denominated bonds.

The Bloomberg Barclays Global Aggregate Bond Index is an unmanaged index of global investment-grade fixed-income securities.

The Bloomberg Barclays U.S. Corporate High Yield Index covers the universe of fixed rate, non-investment grade debt, including corporate and non-corporate sectors.


Important Information:

In the U.S. - INVESTMENT PRODUCTS: NOT FDIC INSURED | NO BANK GUARANTEE | MAY LOSE VALUE

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index.

Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.

This material is only for distribution in those countries and to those recipients listed.

All investors in the UK, professional clients and eligible counterparties in EU and EEA countries ex UK and Qualified Investors in Switzerland.
Issued and approved by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444.

All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC. The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission. Investors should read the offering document prior to any subscription. Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only. Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia:
This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) ("Legg Mason"). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client's professional advisers.

Weekly Market Snapshot

9 October 2017

The Fed wins one: U.S. wages “We are seeing some sun break through, but it is not a clear sky.”

– International Monetary Fund (IMF) head Christine Lagarde, on the IMF’s growing confidence in global growth.

THE WEEK IN REVIEW...

Good call: U.S. wages The most widely-noticed figure in the September jobs report was the 2.9% year-over-year increase in average hourly earnings – well above consensus expectations. That rise was achieved without an increase in hours worked – suggesting that per-hour wages have headed upward. The figure lent additional support to Fed Chair Janet Yellen’s expectation that wage growth is right around the corner. Little wonder, then, that the fed funds futures market is trading as if the odds of a December rate hike are just north of 80%. That’s a dramatic reversal from the 21.8% of September 7; by the time the FOMC met on September 20, the market had already raised its estimate to just over 60%.

Germany: Jamaica coalition? According the forecast of Wolfgang Schäuble, a senior member of Angela Merkel’s Christian Democratic Union (CDU), the post-election ruling coalition will consist of the conservative CDU, the Free Democrats (FDP), and the Green party. The three parties, represented by the colors black, yellow and green (the colors of Jamaica’s flag), was made necessary by the dramatic losses by the Social Democrats (SDP) and their decision to part ways with Merkel’s party. The result could be an increasingly centrist parliament, and a tilt toward more involvement in European Union (EU) politics – a change from the somewhat hands-off approach of the previous government.

UK: The Bank of England ups the ante According to Bank of England (BoE) Deputy Governor Sam Woods, Britain’s banks will need a watertight Brexit transition deal by Christmas in order to prevent an increased flow of people and banking operations to the EU.

China and the World Bank: On the same page The World Bank’s October report on the East Asian and Pacific economies adds to the consensus view – both by China’s government and outside observers – that the country’s “shadow banking” could add to the challenges presented by the growing amount, and kinds, of debt. “Shadow banking” can refer to relatively unregulated financial institutions which take deposits by individuals and borrow against those assets to magnify returns. The People’s Bank of China (PBoC) has singled out these entities as a source of concern as well.

Sources: Bloomberg, Wall Street Journal, Deutsche Welle, The Telegraph.

... CHART OF THE WEEK:

Income: Looking at Low-Vol


Chart of the week

Source: Bloomberg, as of 10/2/2017. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • While it’s the prospect of more stable returns that typically draws investors to low-vol equity strategies, income-seekers may be pleasantly surprised by the dividend component built into many of those strategies.
  • With its yield now topping 4%, the S&P 500 Low Volatility High Dividend Index leads both the S&P 500 and Russell 3000 – as well as the major U.S. bond index, the Bloomberg Barclays Aggregate.
  • Obviously, that does not apply to every low-vol, high-div strategy. Active managers may choose to balance the volatility and income elements in different ways. But it is indicative of the income potential inherent in this approach.
  • It’s important to note that dividends, in this context, can be one of the key indicators of a company with good balance sheets and solid long-term prospects.
  • In principle, those firms’ stocks should tend to be less vulnerable to spikes in volatility than companies with weaker fundamentals.
  • Or as James Norman, President of QS Investors, puts it: “high-quality companies with [solid] cash flows, and which are expected to have those cash flows going forward, are typically stocks that people go to in times of stress.”
  • That helps to explain why these strategies are able to exhibit less variation in performance than equities in general -- as reflected in the lower standard deviation of the Low Volatility High Dividend Index – while providing a yield well beyond that of the U.S. Aggregate Index.

The chart:

  • The chart displays the dividend yields as of 10/2/17 for the S&P 500 Low Volatility High Dividend, S&P 500 and Russell 3000 total return indexes, and of the Barclays Bloomberg U.S. Aggregate Bond Index; and the average standard deviations of the monthly returns for the four indexes over the past 10 years.

1 Source of all data is Bloomberg


DEFINITIONS:

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

The S&P 500 Low Volatility High Dividend Index measures the performance of the 50 least-volatile high dividend-yielding stocks in the S&P 500.

The Russell 3000 Index is an unmanaged index of the 3,000 largest U.S. companies.

The Bloomberg Barclays U.S. Aggregate Index is a broad-based bond index comprised of government, corporate, mortgage and asset-backed issues, rated investment grade or higher, and having at least one year to maturity.


Important Information:

In the U.S. - INVESTMENT PRODUCTS: NOT FDIC INSURED | NO BANK GUARANTEE | MAY LOSE VALUE

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index.

Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.

This material is only for distribution in those countries and to those recipients listed.

All investors in the UK, professional clients and eligible counterparties in EU and EEA countries ex UK and Qualified Investors in Switzerland.
Issued and approved by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444.

All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC. The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission. Investors should read the offering document prior to any subscription. Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only. Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia:
This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) ("Legg Mason"). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client's professional advisers.

Weekly Market Snapshot

2 October 2017

“Forecasts are not facts”

– Federal Reserve Vice-Chair Stanley Fischer, on the Fed’s widely-followed “dot plot” forecast.

THE WEEK IN REVIEW...

Japan: Snap decision With the country’s economy showing new signs of life in inflation (2%) and manufacturing (PMI rising to a 4-month high of 52.6), Prime Minister Shinzo Abe called for a snap election in Japan’s lower house for October and proposed a massive 2 trillion-yen ($18 billion) stimulus package to be drawn up by the end of the year. In response, Japan’s opposition Democratic Party struck an alliance with Tokyo Governor Yuriko Koike’s newly-formed Party of Hope.

Eurozone: No relief for ECB Figures released Friday showed no uptick in the inflation rate, which came in slightly below expectations at 1.5%. As in the U.S., wage growth has remained anemic despite increased hiring, failing to prod inflation higher or provide a rationale for the European Central Bank to begin scaling back its bond-buying program, as the Federal Reserve intends to do in October.

U.S. jobs: Labor gap How much slack is left in the U.S. job market remains a dominant issue in the Federal Reserve’s calculus for future rate hikes. A new academic study1 concludes there may be substantially less slack than thought, because a large and growing percentage of prime-working-year men (ages 25 to 54) have effectively withdrawn from the labor market. If true, this would make the labor pool much shallower, and imply the U.S. economy is much closer to full employment.

EU: Hello neighbor French President Macron called for increased policy integration within the European Union (EU) at its conference in Tallinn, Estonia; a major question is German Chancellor Merkel’s support given changes to her own political landscape. While Merkel praised Macron‘s proposals as “a good basis...to work in an intensive way between Germany and France” , some question how much backing she can deliver given her need to form a new coalition government after losing support in Germany’s recent election.

1 From economist Scott Winship of George Mason University

Sources: Bloomberg, Wall Street Journal, Deutsche Welle, Nikkei Asian Review (Tokyo)

... CHART OF THE WEEK:

Volatility: Always be ready

S&P 500Low Volatility High Dividend versus S&P 500

Source: Bloomberg, as of 8/31/2017. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • Stock market volatility has been muted lately, but that can change quickly, with little warning.
  • For investors who want to guard against a sudden downturn, the dilemma is how to do so without sacrificing near-term opportunity.
  • Low-volatility strategies built around dividend stocks represent an intriguing solution—because they allow investors to participate in long-term market gains without necessarily penalizing performance.
  • Consider the S&P 500 Low Volatility High Dividend Index—composed of the 50 least volatile high dividend stocks in the S&P 500. For the 10 years ending 8/31/17, it generated an average annual total return of 11.72—well above the 7.61% return for S&P 500 itself.2
  • And with a trailing 12-month dividend yield of 4.07% for the S&P 500 Low Volatility High Dividend Index compared with just 1.98% for the S&P500, “a low-vol hi-div” approach could offer a measure of comfort for clients who want income but are concerned about volatility given current valuations and political/policy risks.
  • Indeed, Legg Mason’s multi-asset manager QS Investors, which runs several strategies in this area, makes a compelling case that “low-vol/high div” deserves a dedicated allocation in a well-diversified portfolio—because it allows investors to stay ready for volatility, whenever it may come.

The chart:

  • The chart shows the comparative performance of the S&P 500 Low Volatility High Dividend and S&P 500 total return indexes for the 10-year period 8/31/07 – 8/31/17 with both re-indexed to 100 on 8/31/07.

2 Source for all data is Bloomberg.


DEFINITIONS:

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

The S&P 500 Low Volatility High Dividend Index measures the performance of the 50 least-volatile high dividend-yielding stocks in the S&P 500.


Important Information:

In the U.S. - INVESTMENT PRODUCTS: NOT FDIC INSURED | NO BANK GUARANTEE | MAY LOSE VALUE

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index.

Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.

This material is only for distribution in those countries and to those recipients listed.

All investors in the UK, professional clients and eligible counterparties in EU and EEA countries ex UK and Qualified Investors in Switzerland.
Issued and approved by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444.

All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC. The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission. Investors should read the offering document prior to any subscription. Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only. Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia:
This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) ("Legg Mason"). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client's professional advisers.

Weekly Market Snapshot

25 September 2017

Inflation: Baffling The Fed
“The shortfall in inflation…is more of a mystery [this year], and I will not say the Committee clearly understands what the causes are”

– Federal Reserve Chair Janet Yellen, September 20th press conference

... The week in review:

The Fed: It’s official As expected, the Federal Reserve’s (Fed) September meeting ended with confirmation that its long-anticipated balance sheet roll-down will begin in October. The meeting also raised the prospect of another rate hike in December, with 12 of 16 members of the Fed’s rate-setting Committee leaning toward such a move in spite of persistently weak inflation data. But longer-term, the median estimate for the target rate in 2019, derived from individual members’ expectations, fell to 2.75% from 3%. For more detail on the Fed’s decision, including comments from managers Brandywine Global and Western Asset, read Western Asset does not see an imminent debt crisis in China.

Canada: Big growth, but... Canada reported a smaller-than-expected federal budget deficit for the 2016-2017 fiscal year, the latest reflection of the strong growth in the economy. Canada’s GDP grew 3.7% for the 12 months through June 30—its best rate in more than a decade and the highest of any G-7 nation; the annualized growth rate for the quarter was 4.5%—blistering by today’s developed market standards. In response, Canada’s central bank has raised its target rate twice since July (it now sits at 1%), helping its currency to rise 10% versus the US dollar since June. Yet factory sales statistics for July showed a 2.6% drop—much more than expected and the second straight monthly decline. The weakness was largely attributed to excess auto inventory buildup—and pressure on a booming housing market as the government takes measures to cool it off. Further clouding the outlook is a 10% drop in exports in June and July, fully reversing 2016’s gains.

Germany: Electoberfest Ahead of Sunday’s national elections, Germany’s finance ministry announced new data that points to solid economic growth continuing this quarter, even though retail sales, industrial orders and manufacturing output disappointed in July. Not that Chancellor Merkel was in need of any last minute good news—her Christian Democratic Union/Christian Social Union parties are ahead of their biggest rival, the Social Democratic Party by double-digits according to the latest opinion polls. That popularity is not unsurprising given record-high employment, rising real wages and low borrowing costs—economic conditions that favor domestic consumption as well as corporate profitability.

Sources: Bloomberg, Wall Street Journal, Legg Mason

... CHART OF THE WEEK:

Income: The long unwinding road

Chart of the week

Source: Bloomberg, as of 8/31/2017. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The bottom line:

  • Generating meaningful income in a low rate environment has been a central challenge for investors for years.
  • Now, some investors are wondering if the widely expected unwinding of the Federal Reserve's asset purchase program (known as quantitative easing)—could disrupt the present interest rate landscape and create additional concerns.
  • Yet there are many reasons to believe that this could take place without significant market disturbance—starting with the fact that liquidation of assets is expected to be substantially more gradual than the acquisition.
  • Even more important to consider, however, is the reality that today’s low yield and tight spread environment is not just the result of central bank policies.
  • Two key influences on yields—growth and inflation—have been slow and low, despite the Fed's best efforts to accelerate them. And tight spreads are in large part the result of healthy corporate balance sheets.
  • Those factors aren’t seen changing anytime soon—perhaps extending the relatively stable rate environment with low yields and tight spreads.
  • In fact, at the end of August the 10-year forward U.S. Treasury curve forecast a very gradual increase of about 100 basis points—meaning the market currently expects 10-year Treasury rates to be just above 3% in 2027.1
  • Such market conditions arguably play to the strengths of active managers like Western Asset and Brandywine Global that offer value-oriented strategies which can pursue investments in nontraditional sectors where income opportunities may be more attractive.
  • For more on the Fed’s decision, including comments from Legg Mason affiliate managers Brandywine Global and Western Asset, visit our central bank watch feature The Great Unwind Begins.

The chart:

  • The chart shows the Federal Reserve’s balance sheet from August 2007 – August 2017.

1 Source for all data is Bloomberg


DEFINITIONS:

A basis point is one one-hundredth (1/100, or 0.01) of one percent.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Quantitative easing (QE) refers to a monetary policy implemented by a central bank in which it increases the excess reserves of the banking system through the direct purchase of debt securities.

A spread is the difference in yield between two different types of fixed income securities with similar maturities.


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