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Its not too late to invest

2015 Economic and Market

A special publication from our Investment Strategy Committee

Economy

U.S. equities

U.S. fixed income

International

Alternative investments

The U.S. economy should


outperform others,
potentially creating
investment opportunities.

We expect further increases


in corporate earnings and
stock prices.

Investors may need to


rethink strategies in light of
probable Fed policy changes.

Investors may see


improvement in the world
economy and international
markets.

Despite a disappointing
2014, we believe 2015 shows
promise.

Please see page 15 for important disclaimers.

Economic and market forecast


As of November 19, 2014, unless otherwise noted

Forecasts and
recommendations in
this report are produced
by analysts and strategists
on the Wells Fargo Advisors
Investment Strategy
Committee.

Economy
Inflation-adjusted GDP
Inflation-adjusted GDP
Unemployment
CPI inflation
Federal deficit
Existing home sales (SAAR*)
Total vehicle sales (SAAR*)

rolling four quarters


latest quarter percent change annual rate
end of period/latest
12-month average
rolling 12-months
end of period/latest
end of period/latest

U.S. equity
S&P 500 index
S&P operating earnings
S&P 500 price/earnings

latest (as of 11/19/14)


trailing four quarters
trailing four quarters operating earnings

U.S. fixed income

2014 latest

2015 year-end forecast

2.3% 1
3.5% 1
5.8% 2
1.7% 2
$0.5 tril. 2
5.3 mil. 2
16.4 mil. 2

2.8%
5.4%
1.8%
$0.4 tril.
5.8 mil.
17.5 mil.

2014 latest

2015 year-end forecast

2,048.72
$117.00/shr.
17.5

2,150-2,250
$128.00/shr.
17.2

2014 latest

2015 year-end forecast

0.09%
2.36%
3.08%

0.75%
3.00%-3.50%
3.50%-4.00%

International, commodities and currency

2014 latest

2015 year-end forecast

MSCI EAFE index


MSCI Emerging Markets index
Oil (per barrel)
Gold (per troy ounce)
U.S. dollars per euro

1,820.89
989.91
$74.58
$1,182.72
$1.26

1,950-2,050
1,050-1,130
$88.00-$92.00
$1,050-$1,150
$1.22-$1.26

Target federal funds rate


10-year Treasury yield
30-year Treasury yield

*SAAR = Seasonally adjusted annual rate

latest (as of 11/19/14)


latest (as of 11/19/14)
latest (as of 11/19/14)

latest (as of 11/19/14)


latest (as of 11/19/14)
latest (as of 11/19/14)
latest (as of 11/19/14)
latest (as of 11/19/14)
1 = Data as of third-quarter 2014

2 = Data as of October 2014

Sources: Bloomberg, Wells Fargo Advisors

Recommended tactical portfolio weightings


As of November 19, 2014

Asset classes
Overweight

Evenweight

Underweight

International developed stocks


U.S. large-cap stocks

Cash alternatives
Commodities
Emerging-market stocks
High-yield securities
Intermediate-term IG bonds
International emerging market fixed income
REITs
Short-term IG bonds

International developed fixed income


Long-term IG bonds

U.S. mid-cap stocks


U.S. small-cap stocks
See sector weightings definition on page 14.
IG - Investment grade - Treasuries, agency securities, mortgage-backed securities, corporate bonds, and municipal bonds.

Please see page 15 for important disclaimers.

Source: Wells Fargo Advisors

Key messages from our report


Economy

U.S. equity

Be positive, not defensive

Onward and upward

We believe 2015 may be the year when consumer confidence catches up


with business confidence. If so, investor confidence could also improve.

We expect the U.S. stock market will continue to trend higher in 2015.

The U.S. economic expansion could continue for several more years as there
is good news when looking at consumer and business finances, U.S. crude
oil production, and overall economic performance.

U.S. fixed income

The November through May period tends to be a seasonally positive


one for stocks and to show a leaning toward cyclically sensitive issues
versus defensive.
We recommend investors carry overweight positions within cyclically
sensitive sectors for participation in this mid-cycle portion of the current
economic cycle.

International

10

A slow transition

We expect better days ahead

We expect the Fed will begin increasing short-term interest rates during
the summer of 2015.

The world economy and international markets are likely to improve in 2015,
helped by a strengthening U.S. economy, lower energy prices, subdued
inflation, and international government stimulus.

Short-term rates should increase with greater velocity than long-term rates,
causing the yield curve to flatten.
We strongly advise investors to avoid overconcentration to any particular risk.
A balanced position should generate acceptable performance while limiting
risk and allowing for allocations to be adjusted if volatility increases.

Alternative investments

12

A brighter tomorrow?
For 2015, strategies that focus on buying and selling domestic stocks should
gain from the increased volatility we anticipate.
Event driven and private capital strategies should do well as a result of
strong corporate balance sheets and increased demand for more innovative
lending solutions.
For the long term, we continue to believe diversifying alternative investment
holdings may be the best way to benefit from a variety of strategies that tend
to do well under diverse economic circumstances.

Please see page 15 for important disclaimers.

Investment demand for gold and silver is fading. We recommend reallocating


precious metals positions into a broadly diversified commodity position.
We advise against giving in to the urge to sell off international positions in
this environment of a strong U.S. dollar and prospective U.S. economic and
equity market outperformance.

Talk to your Financial Advisor


The 2015 Economic and Market Outlook offers our
perspective on whats happened this year as well as our
forecast for the year ahead.
You may want to discuss these key points with your
Financial Advisor to determine whether adjustments
to your investments may be needed to help you stay
on track toward your goals.

2015 Economic and Market Outlook

Economy

Be positive, not defensive


U.S. economy should outperform others, potentially creating investment opportunities
The global economy is likely to increase only
modestly in 2015, especially during the years first
half. Economic growth slowed significantly in
Europe and Japan in 2014. In addition, Chinese
economic growth continues to slow as that country
transforms from an economy based on exporting to
one fueled by domestic spending.
Gary Thayer
Chief Macro Strategist

2015 year-end

forecasts

2.
8
inflation-adjusted GDP
Rolling four quarters

5.4 unemployment
End of year

1.8 CPI inflation


-month average

The good news is global inflationary pressures are


subsiding during this period of economic weakness,
allowing consumers and businesses to stretch their
spending further. Equally important, monetary
policymakers in Europe and Japan are attempting to
boost economic growth by purchasing assets
following policies similar to the Feds recently
completed quantitative easing program. However, it
may take time for these efforts to produce results.
Fortunately, U.S. economic policies have been more
effective in boosting economic activity. Therefore,
our economy is likely to be stronger than many
others throughout most of 2015.
We project inflation-adjusted gross domestic
product (GDP) growth will average 2.8% in the four
quarters of 2015. That would be better than the
current consensus expectation for economic growth
to average 2.2% this year. In addition, we expect the
12-month consumer price inflation rate to average
only 1.8% in 2015.

Disappointing economic news in foreign economies


could create some volatility in global financial
markets during 2015. However, we believe investors
should not get too defensive but should remain
positive and take advantage of opportunities that
volatility creates.

Confidence likely to improve further


One of the positive surprises in the U.S. economy in
2014 has been the improvement in the labor market.
Unemployment has been trending down since the
end of the 2008-2009 recession. The jobless rate
dropped to less than 6.0% in late 2014 as layoffs
subsided and companies added workers.
Unfortunately, many workers who lost jobs during
the recession are not getting the new ones.
Consequently, consumer confidence still appears to
be lagging business confidence. But we believe 2015
will be the year when consumer attitudes finally
catch up to the improvements in the U.S. economy. If
so, we would also expect investor sentiment to
improve at the same time.

Source: Wells Fargo Advisors

Consumer confidence making a comeback


150
Civilian unemployment rate

Already on a rebound,
consumer confidence
is likely to improve further.

Consumer confidence index

125
100
75
50

Index 1985 = 100


25

95

00

05

10

15

Sources: The Conference Board, Haver Analytics, and Wells Fargo Advisors

Please see page 15 for important disclaimers.

Federal budget deficit picture has improved


The federal budget
deficit is significantly
less than it was at the
end of the recession.

$400

Federal budget surplus (+) or deficit (-)

Billions

$0
$-400
$-800
$-1,200

Recessions
$-1,600

95

00

05

10

15

Sources: Haver Analytics and Wells Fargo Advisors

Fed likely to raise rates


As economic activity continues to improve, the U.S.
economy should no longer need the economic
stimulus exceptionally low short-term interest rates
provide. However, the Fed has indicated short-term
rates could remain low for a considerable period
following the October 2014 ending of its
quantitative easing program. We believe that means
the Fed is likely to wait to start raising these rates
until summer 2015.
If we are correct, the Fed would then be waiting until
the global economy starts to respond to the
economic stimulus out of Europe and Japan,
reducing the risk that the Fed would be raising rates
while the rest of the world is still weak.

Twin U.S. deficits decline


In addition to the improving U.S. economy, the
federal budget deficit and the U.S. trade deficit have
been positive surprises.
As employment grows, more people are working
and paying taxes. At the same time, government
spending on income support programs is growing
more slowly. As a result, the U.S. federal budget
deficit has dropped to less than 3.0% of GDP. This
means the U.S. governments total debt is rising at a
slower pace than a few years ago when the
government was borrowing more money to finance
bigger yearly deficits.

Please see page 15 for important disclaimers.

The U.S. trade deficit has also improved recently as


the United States produces more domestic oil and
natural gas, requiring less importing of foreign
energy. The decline in imports means there are
fewer dollars going overseas, dampening the supply
of the U.S. currency in foreign exchange markets.
This reduced supply of dollars from trade is
occurring at the same time that the demand for
dollars has improved as foreign investors look more
favorably on the stronger U.S. economy and the
decline in the federal deficit. As a result, the dollars
value has strengthened.
We believe the last time the U.S. economy has been
in a situation similar to the current environment was
in 1997. That was the sixth year of the long
economic expansion of the 1990s. It was also a
period when the dollars value was strengthening
because the U.S. economy was stronger than many
foreign economies, especially several Asian
economies which suffered currency crises that year.
And that slow global economic growth dampened
inflationary pressures. Of course, past performance
does not guarantee similar results. Nevertheless, the
U.S. economy continued to expand for several more
years and did not go into recession until 2001.

2015 Economic and Market Outlook

U.S. equities

Onward and upward


We expect further increases in corporate earnings and stock prices

Stuart Freeman, CFA


Chief Equity Strategist

2015 year-end

forecasts

128.00

S&P 500 earnings

2,150-2,250
S&P 500 index
Source: Wells Fargo Advisors

Our 2014 outlook called for the continuation of the


slow-growth economy with moderate earnings
growth and inflation. We expected greater volatility
as the Fed continued to taper its quantitative easing
bond purchases. During the Feds three quantitative
easing phases, the markets traded on a bed of
liquidity. When negative events led to selling
pressures in recent years, liquidity, low inflation, and
low interest rates enticed many investors to quickly
buy on pullbacks.
We also believe the recent years low market
volatility levels resulted from investors
unwillingness to broadly speculate in stocks
following the dramatic market declines during the
last two recessions. Thus, pullbacks have tended to
start from moderate valuation points (and even
relatively attractive levels versus interest rate levels).
This low volatility does not represent the norm.
Regardless of our expectations for increasing
volatility, we anticipated late in 2013 that the S&P
500 Index would trade higher by year-end 2014.
Although poor weather conditions negatively
impacted first-quarter fundamentals, we enjoyed
catch-up growth during the second quarter.
During the years first two quarters, S&P 500 Index
operating earnings increased at an 11% rate. Thirdquarter earnings appeared a touch stronger. In
addition, earnings breadth (higher versus lower
earnings) during the first nine months of 2014 hit
the strongest level since 2010. This favorable
earnings breadth is in keeping with the breadth of
job growth across domestic economic segments
during the past 18 months.

Throughout 2014, we recommended long-term


investors use market pullbacks as opportunities to
accumulate quality issues. During September and
October, the combination of Fed tapering, soft
international growth, ISIS and Ebola concerns,
mid-term election chatter, and a history of seasonal
weakness resulted in a nearly 10% correction for the
S&P 500 Index. In the pullback, we suggested
investors tactically overweight large-capitalization
domestic stocks, taking the funds from cash.

More of the same ahead


From our vantage point, the forward-looking
domestic fundamentals have not changed. Our
expectations for many leading indicators, market
breadth, job growth and breadth, consumer
confidence, and personal spending support our
outlook for continuing broad economic expansion in
2015. We also continue to foresee further housingand manufacturing-segment growth.
When stocks pulled back this fall, so did oil and gas
prices, inflation expectations, and 10-year Treasury
yields. Stocks appeared more attractive at lower
levels, especially relative to the lower yields.
We continue to project 2015 S&P 500 Index
operating earnings of $128 versus $120 in 2014.
During the autumn pullback, we remained
comfortable with our year-end 2015 S&P 500 Index
target range of 2,150-2,250. Overall, slow
international growth and a stronger dollar are likely
to result in a continuation of moderate inflation
levels and offer potential price/earnings (P/E)
multiple expansion of the S&P 500.

2015 opportunities in U.S. equities


As of December 2, 2014

Overweight*

Evenweight*

Underweight*

Consumer Discretionary
Industrials
Information Technology

Energy
Financials
Health Care
Materials
Telecommunication

Consumer Staples
Utilities

*See sector weightings definition on page 14.

Please see page 15 for important disclaimers.

Source: Wells Fargo Advisors

Higher rates may not hurt stocks


50%
Change in S&P 500 Index

During the Feds last


two tightening cycles,
the S&P 500 Indexs
performance was
consistently positive
for long periods after
the first interest rate
increase.

Forward 12-month period beginning Feb. 1994


Forward 12-month period beginning Feb. 2004

40%
30%
20%
10%
0%
-10%
1

11

13

15

17

19

21

23

25

27

29

31

33

35

Months from first rate increase


Past performance is not an indication of future results.

Still mid-cycle with rate increases ahead


In recent quarters, inflation and interest rate levels
have run below average street expectations.
Although job growth increased at a 200,000-plus
rate in October for the ninth month in a row
(something not seen since the nine months through
March 1995), inflation levels are still running below
the Feds preferred 2% target. Wage inflation is
stagnant; this remains an issue for the economy, the
Fed, consumers, and voters.
Nonetheless, we believe 2015 will see the beginning
of interest rate increases. The Fed has already begun
to reduce its easing process through tapering; we
expect it may begin to tighten next summer and
perhaps once more by year-end 2015. The start of
Fed tightening generally suggests it believes the
domestic economy can expand with less help.
Increases suggest the Fed is more comfortable with
labor market metrics and that the economy can
move closer to full potential and a healthy inflation
level.
Of course, no cycle is exactly like another. Each has
its own idiosyncrasies. However, there are some
similarities across phases of economic recoveries.
Consider the market performance from the point at
which the Fed started to increase rates during the
last two cycles (the periods beginning in February
1994 and June 2004). In those cases, S&P 500
Index performance was persistently positive in
forward 12-month periods starting from the
beginning of rate increases and continuing well
beyond the start of those rate increases.

Please see page 15 for important disclaimers.

Sources: Factset, Conference Board, Wells Fargo Advisors

We have included a chart of 36 months of forward


12-month changes in the S&P 500 Index beginning
with the initial fed funds rate increases in those two
cycles. The blue bars represent forward 12-month
S&P 500 Index changes for tightening that started
in February 1994; the red bars depict the forwardlooking market changes during the tightening cycle
starting June 2004.
For both cases, positive fundamentals continued to
support the stock market during the back end of the
cycles, despite periods of rate increases.
Furthermore, the returns of the 10 primary S&P 500
Index sectors were broad (on a 12-month forwardlooking basis for 36 months following initial rate
increases). The number of sectors that declined over
one-year periods during the 1990s example
averaged less than one out of 10. The average
decline was one out of 10 sectors in the 2000s
example.
As we look into 2015, the November through May
period tends to be a seasonally positive one for
stocks; it also tends to be a period that shows a
leaning toward cyclically sensitive issues versus
defensive. We recommend investors carry
overweighted positions within the cyclically
sensitive Industrial, Information Technology, and
Consumer Discretionary sectors for participation in
this middle portion of the current economic cycle.

2015 Economic and Market Outlook

U.S. fixed income

A slow transition
Investors may need to rethink strategies in light of probable Fed policy changes

Brian Rehling, CFA


Chief Fixed Income Strategist

2015 year-end

forecasts

The coming year is likely to be one of transition for


the fixed income markets. We expect the Fed to
move off of its policy of keeping rates essentially at
zero. Short-term rates will remain extremely low by
historical standards, but it has been over six years
since the federal funds target rate was above
virtually zero. Many investors have adapted their
income and fixed income investment philosophies
to account for a zero short-term rate environment;
however, as short-term rates rise over time,
strategies that were effective in the current
environment may become less desirable for some
investors.

potential to make messaging a difficult task for the


Fed in the upcoming year. If the Fed does not clearly
communicate its intentions to the market, fixed
income volatility may increase in the year ahead.

Fed impact

In longer maturities, we expect only modest


increases in rates as the interest-rate curve flattens.
Still, investors should remember that it takes only
small increases in longer-term interest rates to have
a significant negative price impact on longmaturity/duration fixed income positions.

0.75
target federal

We expect the Fed will begin increasing short-term


interest rates next summer. Our federal funds target
is 75 basis points1 at year end, implying two
increases over the course of 2015.

3.
00 -3.50
10-year Treasury yield

We expect the Fed to take a measured and datadependent approach that may result in long pauses
between incremental increases in short-term rate
policy, at least initially. Such an approach has the

funds rate

3.50
-4.00
30-year Treasury yield

As we move closer to an eventual increase in the


federal funds rate, we expect short-term rates will
increase at a greater velocity than long-term rates.
The bond market is likely to adjust in advance of an
actual increase in interest rates. For many investors,
higher short-term interest rates could be a
significant positive development providing
meaningful risk-free returns for the first time in
more than six years.

Curve flattening should be expected well into and


through the next Fed tightening cycle. Our 2015
targets allow for modest curve flattening as shortterm rates move higher. Our 2015 30-year U.S.
Treasury target is 3.50%-4.00%, just 50 basis points
over our 10-year 3.00%-3.50% target.

A basis point is 1/100 of one percent.

Source: Wells Fargo Advisors

2015 opportunities in U.S. fixed income


As of December 2, 2014

Overweight

Slight
overweight

Evenweight

Slight
underweight

Agency securities

U.S. Treasuries

Underweight

Duration
Slightly short*

Corporate bonds
Mortgage-backed
securities
Municipal bonds
Preferred securities
Treasury InflationProtected Securities
See page 14 for duration definition.

Source: Wells Fargo Advisors

*We recommend a duration slightly short of an investors target duration. If an investor does not have a target duration, we recommend
a duration of approximately 4.75 years in taxable portfolios and 7.25 years for tax-exempt portfolios.

Please see page 15 for important disclaimers.

Yield curve has flattened after fed funds rate increases

n
tte
fla
s

ttens
Curve fla

rve

100

Cu

200

20%

se

s ri

e
Rat

Rates rise

10%
5%

Rat
e

-100

s ris
e

15%

Federal funds target rate

300

25%

10-year yield minus 2-year yield


Fed funds target rate

flatten

Curve steepness (basis points)

400

Curve

Historically, the yield


curve has flattened
significantly in periods
when the Fed increased
the federal funds
target rate.

-200
0%
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14
Past performance is not an indication of future results.

A flattening curve
The interest rate curve flattened significantly in
other periods in which the Fed increased the federal
funds target rate. The flattening often occurred over
a number of years, with the two-year Treasury yield
moving above the 10-year Treasury yield by the end
of each of the last three tightening cycles. We think
the current cycle will likely follow a similar path,
although we expect the curve flattening to be drawn
out and occur over a number of years; investors
should not fear that the current expansionary
economic phase is nearing an end.

Potential investment implications


Traditional fixed income: Investors in traditional
fixed income have struggled with low yields for
many years. The threat of rising interest rates has
also been a concern for these investors. For most
investors, high-quality fixed income securities
continue to deserve a meaningful allocation in
portfolios. Core bond positions can help reduce
portfolio volatility and be a source of stability during
equity market corrections.
High yield: In past tightening cycles, we have seen
significant credit spread widening and
underperformance in the high-yield space, but not
until near the end of Fed tightening as rate increases
slow the economy, the yield curve inverts, and
recessionary conditions take hold.

Please see page 15 for important disclaimers.

Source: Bloomberg, Wells Fargo Advisors

Municipals: We expect that spending cuts will


continue in 2015 due to the ongoing federal
government sequester and 2014 mid-term election
results, which will support the municipal market by
limiting new supply as was the case in 2014. This
could be somewhat offset by reduced demand due to
less attractive relative valuations, which may
continue to decline from two-year highs set in 2013
should yields on taxable bonds begin to rise in 2015.
Investors should be prepared for income strategies
to struggle relative to recent performance as the
curve flattens there is the potential that this could
lead to liquidity concerns in certain products or
asset classes at some point. While we remain
concerned about this space, we recognize that
avoiding credit risk in the income space will likely
quickly hinder performance absent a near-term
correction (giving up yield in a low-yield world
quickly drags down performance). The impact is
further magnified for portfolios that are also short
duration.
In 2015 we look to balance credit and interest rate
risk to maintain performance while strongly
advising that investors avoid overconcentration to
any particular risk. A balanced position should allow
for investors to experience acceptable performance
while limiting risk and allowing for allocations to be
adjusted should volatility increase.

2015 Economic and Market Outlook

International

We expect better days ahead


Investors may see improvement in the world economy and international markets

Paul Christopher, CFA


Chief International Strategist

2015 year-end

forecasts

1,950-2,050
MSCI EAFE equity index

1,050-1,130
MSCI Emerging-market
equity index

88.00- 92.00

Crude oil per barrel

1,050- 1,150

Gold per troy ounce

1.22- 1.26

Concern about global economic and earnings


growth coincided with weaker international markets
in late 2014. However, the world economy and
international markets are likely to improve in the
second half of 2015, helped by a strengthening U.S.
economy, lower energy prices, subdued inflation,
and government stimulus in the form of
exceptionally low interest rates notably in Europe
and Japan. Manufacturers around the world appear
to agree: As the chart on page 11 shows,
manufacturers in nearly 80 percent of non-U.S.
countries surveyed expect expansion next year, a
higher share than earlier in 2014.
The world economy is, nevertheless, improving
more slowly than the U.S. economy, and the
difference should be sharpest in the first half of 2015
while stimulus policies gradually take effect. That
difference should favor the dollar over its main
competitor currencies, especially in Europe and
Japan. We expect a more mixed outlook for the
dollar against emerging market currencies because
these economies are healthier than those of Europe
and Japan and, being the most reliant on energy,
also benefit the most from reduced energy prices.
Global preferences should favor U.S. equity
markets: The stronger U.S. economic growth and
benign inflation prospects should support continued
earnings gains and equity prices. By comparison, the
developed and emerging market economies should
generate less additional momentum, though the U.S.
economys strength should spark faster global trade
to offset much of the sluggish domestic activity.

International fixed income looks somewhat less


attractive than equities: The slow economic pace
and the hope that central banks might buy debt to
stimulate their economies have reduced yields to
unattractive levels in Europe, Japan, Canada, and
Australia. In addition, the U.S. dollars potential
strength against these countries currencies
reinforces our advice to allocate less than the
long-term target to these markets.
However, subdued inflation and a prospective
pickup in economic growth create a neutral outlook
for emerging market sovereign debt. Moreover,
emerging market debt denominated in dollars
should help investors diversify income sources and
avoid the risk of currency depreciations. We
recommend investors take emerging market,
dollar-denominated debt holdings toward their
long-term target allocations.

Commodity supplies expected to rebound


In general, we expect closer commodity supplydemand in 2015 and single-digit returns in 2015. For
two years, miners have struggled to rein in supply
and are starting to restore a supply-demand balance.
Recent energy price declines have coincided with
worries about slow global economic growth, the
dollars appreciation, and concerns about excess
supply, but crude oil demand continues to grow,
especially in emerging economies. Likewise, grain
markets slashed prices on record 2014 harvests, but
low prices historically induce rising consumption
and reduce planting a year later.

euro exchange rate

2015 opportunities in international and commodity investments


Source: Wells Fargo Advisors

As of December 2, 2014

Asset class

Core

Satellites

Developed Markets Equity


Emerging Markets Equity
Developed Markets Fixed Income

MSCI EAFE index


MSCI Emerging Markets index
S&P/Citigroup International Treasury Bond
Ex-U.S. index
J.P. Morgan Emerging Markets Bond Index Global
DBIQ Optimum Yield Diversified Commodity index

Germany, New Zealand, Switzerland, United Kingdom


Malaysia, South Africa, South Korea, Taiwan
Norway

Emerging Markets Fixed Income


Commodities

None at this time


Energy
Source: Wells Fargo Advisors

10

Please see page 15 for important disclaimers.

Percentage of positive growth forecasts is increasing


Manufacturers in nearly
80 percent of non-U.S.
countries surveyed
expect expansion next
year, a higher share than
earlier in 2014.

100%
80%
60%
40%
20%
0%

Jan.

Feb.

Mar.

Apr.

May

Jun.

Jul.

Aug.

Sep.

Oct.

Monthly data from January 2014 - October 2014.


Sources: Bloomberg and Wells Fargo Advisors
Manufacturer sentiment measured by the Markit purchasing managers' survey for the following sample: Austria, Brazil, Canada,
China, Czech Republic, France, Germany, Greece, India, Indonesia, Ireland, Italy, Japan, Mexico, the Netherlands, Poland, Russia,
South Korea, Spain, Taiwan, Turkey, the United Kingdom, and Vietnam.

Yet, precious metals look unappealing. Falling prices


and geopolitical tensions have fueled physical
demand, but investment demand is much more
important for gold and silver prices and is fading as
U.S. interest rates rise amid low inflation. We
recommend reallocating from precious metals into a
broadly diversified commodity position.

Look for regional opportunities


The trend toward less correlation among financial
markets and between financial and commodity
markets should also produce opportunities next
year. As the recent global crises fade, investment
returns are again following their own driving factors,
instead of moving up or down together, as in the
worst days of the recent crises.
We see the increasingly uncorrelated movements
among global markets as the visible sign of growing
monetary policy and economic growth divergences.
More regional opportunities are likely to arise from
differentiated local and regional market
performances, and equally important, we see the
opportunity to gradually increase international
exposure toward long-term target allocations while
international markets are at an early stage of
economic recovery.

Please see page 15 for important disclaimers.

Resist the urge to liquidate


In this environment of a strong U.S. dollar and
prospective U.S. economic and equity market
outperformance, investors may be tempted to sell off
their international positions. This may have some
benefit in the short run, but it:
Increases exposure to an unfavorable U.S.
economic or political surprise
Leaves the investor with the difficult task of timing
a reentry into international markets later
Denies the possibility of gaining from
diversification
That is, the factors that drive markets are reverting
more toward local conditions, and the differences
across countries may offer investors an opportunity
to reduce the portfolios long-term up and down
swings while gaining from the positive returns we
expect from international investments.

2015 Economic and Market Outlook

11

Alternative investments

A brighter tomorrow?
Despite a disappointing 2014, we believe 2015 shows promise
Renewed bouts of market volatility, policy
uncertainty at home and abroad, and muted returns
across most global asset classes weighed on
alternative strategies total returns in 2014. However,
while alternative strategy performance on average
struggled, pockets of solid individual manager and
strategy performance could be found, particularly
within U.S. equity and more macro focused
approaches.
Unfortunately, for a broader majority of alternative
fund managers, geopolitical turmoil and global
growth concerns continued to influence broad
investor sentiment and markets in unpredictable
ways, making the positive outliers more the
exception than the rule.
However, despite many muted performances in
2014, we continue to believe that going forward the
longer-term value proposition for incorporating
alternatives remains in place particularly given our
belief that the Fed will become relatively less
accommodative in 2015, and correspondingly,
financial asset prices will experience greater
gyrations as market participants become more
cautious.
Alternative strategies can provide enhanced
diversification during such potential bouts of
volatility, while also creating longer-term investment
portfolio return opportunities, as flexible alternative
managers attempt to exploit the distortions in global
asset prices such events create.

Some strategies show particular promise

Overall, our teams broader economic and market


outlook remains constructive, and we believe
conditions remain favorable overall for alternatives,
both in terms of potential diversification and return
benefits. Below are our thoughts on a few of our
favorite strategy types as we head into 2015.
Hedged equity: Despite a challenging 2014, we
expect hedged equity strategies to benefit from the
tailwind of reasonable earnings growth and solid
corporate fundamentals in 2015. In addition, such
strategies may benefit from greater performance
dispersion as decreasing correlations and rising
valuations place additional premium on security
selection. And lastly, an increase in market volatility
may create attractive long-term buying
opportunities for flexible managers as they seek to
opportunistically deploy cash following market
corrections/sell-offs.
Event driven: Strategies relying on corporate
activity to drive returns were some of the hardest hit
in 2014, as crowded merger and spin-off related
transactions and distressed security positions
experienced markdowns during bouts of credit and
equity market volatility. However, despite such
short-term performance struggles, we continue to
favor such strategies going into 2015. With public
company balance sheets still flush with cash, activist
managers continuing to pressure corporate boards
for shareholder-friendly change, and default rates
continuing to remain low, the foundations remain in
place for further potential upside.
Private capital: We continue to maintain a favorable
view of private debt investments as gaps in U.S. and
European bank lending to small- and medium-sized
businesses, combined with increased demand for
more innovative and customized business lending
solutions create opportunities for private funds to
serve as lenders of last resort. This view is further
reinforced by numerous European banks recent
stress test failures, which may lead to greater
divesting of assets by such financial institutions as
they attempt to repair their balance sheets.

12

Please see page 15 for important disclaimers.

Asset allocation

Have an overall plan before you act


To make the process of developing your overall investment strategy easier, Wells Fargo Advisors has crafted
nine models for asset allocation (investment mix) that cover a wide range of objectives from conservative income
to a more aggressive long-term growth allocation . Your Financial Advisor can work with you to choose an
asset allocation specifically addressing your situation, financial goals, and risk tolerance.

Strategic asset allocation models

Income

Conservative
Mid-cap equity 2%
Large-cap equity 2%
REIT equity 3%
High-yield fixed income 4%
International
fixed income* 8%

Moderate
2% International equity
5% Cash alternatives

Growth & income

4% International equity
3% Cash alternatives

Small-cap equity 2%
Mid-cap equity 2%

Mid-cap equity 4%

REIT equity 3%

International equity 13%


Commodities 2%

Mid-cap equity 4%

Small-cap equity 6%

Large-cap equity 13%

High-yield fixed income 9%

Moderate income

Small-cap equity 4%
50%
Traditional
fixed income

9% International fixed income*

Small-cap equity 10%

8% International fixed income*

27%
Large-cap
equity

Mid-cap equity 12%

6% High-yield fixed income


3% REIT equity

2% Cash alternatives

Mid-cap equity 11%

11% Traditional fixed income

8% High-yield fixed income

Moderate growth and income

Cash alternatives 2%

8% Traditional fixed income


2% High-yield fixed income
2% REIT equity

International equity 18%

Small-cap equity 8%

3% Cash alternatives

International equity 15%


Commodities 2%

29%
Traditional
fixed income
22%
Large-cap
equity

Conservative growth and income

Commodities 3%

17% International
fixed income*

Long-term income

3% Cash alternatives

Mid-cap equity 8%

REIT equity 3%
High-yield fixed income 4%
International fixed income* 7%

39%
Traditional
fixed income

REIT equity 3%

International fixed income* 13%

10% International equity


3% Cash alternatives

Commodities 2%

Large-cap equity 15%

54%
Traditional
fixed income

High-yield fixed income 7%

74%
Traditional
fixed income

6% International equity
3% Cash alternatives

Small-cap equity 4%

Large-cap equity 12%

Conservative income

Growth

Long term

24%
Traditional
fixed income
30%
Large-cap
equity

Long-term growth and income

Cash alternatives 2%

International equity 24%


2% High-yield fixed income
2% REIT equity

Commodities 3%
Small-cap equity 14%

Commodities 3%
Small-cap equity 16%

Mid-cap equity 15%

Conservative growth

2% REIT equity

32%
International
equity

30%
Large-cap
equity

Moderate growth

3% REIT equity

28%
Large-cap
equity
17%
Mid-cap
equity

Long-term growth

* Includes emerging-market debt.

Includes emerging-market equities.

Investment objectives

Risk tolerance

Income. Emphasis on achieving current income.

Conservative. The least risk for a given investment objective.

Growth and income. Balance in emphasis between potential capital appreciation and income.

Moderate. A higher degree of risk for the potential to receive higher returns.

Growth. Emphasis is on potential capital appreciation.

Long-term. The highest risk within a given investment objective.

Please see page 15 for important disclaimers.

13

Definitions
Commodities are basic goods used in commerce that are generally
interchangeable with other commodities of the same type. Commodities
are most often used as inputs in the production of other goods or services.
Consumer Price Index (CPI) is a measure of the weighted average of
prices of a basket of consumer goods and services, such as transportation,
food, and medical care. The CPI is calculated by taking price changes for
each item in the predetermined basket of goods and averaging them; the
goods are weighted according to their importance. Changes in CPI are
used to assess price changes associated with the cost of living.
Core is a broad, well diversified position in commodities or international
investments.
Current yield (frequently referred to as yield) is the annual income an
investment provides divided by its current market price. For example, a
bond selling at par ($1,000) paying $100 annually in interest would have
a 10% yield. However, if the bonds market price fell to $900, its yield
would increase to approximately 11%.
Cyclical stocks are typically those of companies that sell discretionary
items that consumers can afford to buy more of in a booming economy
and will cut back on during a recession. In other words, when the economy
is doing well, cyclical investments tend to perform well. The opposite, of
course, is true when the economy is doing poorly. Defensive investments,
on the other hand, tend to be less affected by economic cycle changes.
Defensive stocks tend to be resistant to general stock market fluctuations.
An investor may hold these stocks to help provide their stock portfolio
with some price stability in a volatile market. Utility, gold and silver
producer, and some consumer goods stocks are generally considered
defensive. Cyclical stocks, on the other hand, tend to be more sensitive
to general stock market fluctuations.
Duration can be used to estimate the percentage change in a bonds value
that will result from a 1% change in interest rates. For example, a duration
of four means that a 1% change in prevailing rates in a one-year period
should shift the bonds price in the opposite direction by 4%. The longer
(higher) the duration, the more the bonds price will fluctuate as interest
rates rise and fall.
Emerging markets are financial markets in countries with developing
economies. These markets are typically immature compared to those
of the worlds major financial centers but are becoming increasingly
sophisticated and integrated into international markets; they provide
potentially higher returns but are intensely volatile.
Gross domestic product (GDP) is the total value of the goods and
services the economy produces during a year. Increasing GDP indicates
growing economic activity. Decreasing GDP suggests the opposite.
High yield is noninvestment-grade fixed income securities (rated Ba1 or
lower by Moodys and/or BB+ or lower by S&P). These investments are
considered to be speculative and are subject to a higher degree of risk.

14

Intermediate-term fixed income includes instruments that mature in six


to 12 years.
International investing involves putting money into financial markets in
developed economies outside of the United States.
Large-cap growth stocks have a market cap greater than $10 billion and
a price-to-book ratio greater than 2.3.
Large-cap value stocks have a market cap greater than $10 billion and
a price-to-book ratio less than or equal to 2.3.
Liquidity, in regard to the economy, is a reference to the money supply.
The greater the liquidity, the larger the money supply.
Long-term fixed income includes instruments whose maturities are
greater than 12 years.
Mid-cap growth stocks have a market cap between $2 billion $10 billion
and a price-to-book ratio greater than 2.3.
Mid-cap value stocks have a market cap between $2 billion $10 billion
and a price-to-book ratio less than or equal to 2.3.
Quantitative easing is a Federal Reserve strategy for increasing the money
supply (adding liquidity) to help keep interest rates low and stimulate
economic activity. In general, it involves Fed purchases of bonds from
banks, providing them with money to lend to businesses and consumers.
Real estate investment trusts (REITs) trade on the major exchanges and
invest in real estate directly, either through properties or mortgages.
Satellites are complementary commodity or international positions held
alongside the core (see definition) with the objective of outperforming the
core. Keep in mind that allocations to satellites may increase volatility.
Sector weightings are guidance stock market strategists use to
indicate how they believe investors should allocate their stock portfolios.
When a strategists guidance is to overweight a sector, he or she believes
it will perform well in the future and investors should allocate a larger
percentage of their stock portfolios to that sector than its relative
representation in the S&P 500 index. For example, if the Energy sector
represents 11% of the S&P 500 index and a strategists guidance is to
overweight that sector, he or she is recommending that investors allocate
more than 11% of their stock portfolios to the sector. If a strategists
guidance is to evenweight a sector, he or she believes investors allocation
to that sector should be in line with its representation in the S&P 500.
If a strategists guidance is to underweight a sector, he or she believes
investors allocation to that sector should be less than its representation
in the S&P 500.
Short-term fixed income includes instruments that mature in one to
six years.
Small-cap growth stocks have a market cap less than $2 billion and
a price-to-book ratio greater than 2.3.

Index definitions
An index is unmanaged and not available for direct investment.
DBIQ Optimum Yield Diversified Commodity Index is a measurement of
14 commodities drawn from the energy, precious metals, industrial metals,
and agriculture sectors.
J.P. Morgan Emerging Markets Bond Index Global tracks total returns
for U.S.-dollar-denominated debt instruments issued by emerging-market
sovereign and quasi-sovereign entities.
MSCI EAFE (Europe, Australasia, and Far East) Index is a free floatadjusted market capitalization index that is designed to measure the
equity market performance of developed markets, excluding the U.S. and
Canada. The index consists of the following 21 developed-market country
indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany,
Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand,
Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the
United Kingdom.

MSCI Emerging Markets Index is a free float-adjusted market


capitalization index that is designed to measure equity market
performance of emerging markets. The MSCI Emerging Markets Index
consists of the following 23 emerging market country indexes: Brazil,
Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India,
Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar,
Russia, South Africa, Taiwan, Thailand, Turkey, and United Arab Emirates.
S&P/Citigroup International Treasury Bond Ex-U.S. Index is designed to
reflect the performance of bonds issued by non-U.S. developed-market
countries.
S&P 500 Index consists of 500 industrial, financial, utility, and
transportation companies with market capitalizations of $4 billion
or more.

Disclaimers
Some information contained in this report was prepared by or obtained
from sources that Wells Fargo Advisors believes to be reliable. Any market
prices are only indications of market values and are subject to change.

Mortgage-backed securities are subject to prepayment risks. Changes


in prepayments may significantly affect yield, average life, and
expected maturity.

Wells Fargo Advisors may not offer direct investments into the products
mentioned in this report.

Treasury Inflation-Protected Securities (TIPS) are subject to interest rate


risk, especially when real interest rates rise. This may cause the underlying
value of the bond to fluctuate more than other fixed-income securities.

Asset allocation and diversification do not guarantee a profit or protect


against loss in a declining market.
Investing in foreign securities presents certain risks not associated with
domestic investments, such as currency fluctuations, political and economic
instability, and different accounting standards. This may result in greater
share price volatility. These risks are heightened in emerging markets.
Technology and Internet-related stocks, especially of smaller, less-seasoned
companies, tend to be more volatile than the overall market.
The prices of small- and mid-cap company stocks are generally more
volatile than large-company stocks. They often involve higher risks because
smaller companies may lack the management expertise, financial
resources, product diversification and competitive strengths to endure
adverse economic conditions.
Investing in fixed-income securities involves certain risks, such as market
risk if sold prior to maturity and credit risk, especially if investing in
high-yield bonds, which have lower ratings and are subject to greater
volatility.
Bond prices fluctuate inversely to changes in interest rates. Therefore, a
general rise in interest rates can result in the decline of the value of your
investment. All fixed-income investments may be worth less than original
cost upon redemption or maturity. Government bonds are guaranteed as to
payment of principal and interest by the U.S. government if held to maturity.
Although government bonds are considered free from credit risk, they are
subject to interest rate risk.
Income from municipal securities is generally free from federal taxes and
state taxes for residents of the issuing state. While the interest income is
tax-free, capital gains, if any, will be subject to taxes. Income for some
investors may be subject to the federal alternative minimum tax (AMT).

There are special risks associated with investing in preferred securities.


They are generally subordinated to bonds or other debt instruments in an
issuers capital structure, subjecting them to a greater risk of non-payment
than more senior securities. Preferred dividends are not guaranteed and
are subject to deferral or elimination.
There are special risks associated with an investment in real estate,
including possible illiquidity of the underlying properties, credit risk,
interest rate fluctuations, and the impact of varied economic conditions.
Investing in commodities is not suitable for all investors. Exposure to the
commodities markets may subject an investment to greater share price
volatility than an investment in traditional equity or debt securities. The
prices of various commodities may fluctuate based on numerous factors,
including changes in supply and demand relationships, weather and acts
of nature, agricultural conditions, international trade conditions, fiscal,
monetary and exchange control programs, domestic and foreign political
and economic events and policies, and changes in interest rates or sectors
affecting a particular industry or commodity. Products that invest in
commodities may employ more complex strategies which may expose
investors to additional risks, including futures roll yield risk.
An investment that is concentrated in a specific sector, industry, country, or
commodity increases its vulnerability to any economic, political, currency,
or regulatory development affecting the sector, industry, country, sector, or
commodity, which may result in greater price volatility.
There is no assurance that any of the target prices or other forward-looking
statements mentioned will be attained. Any market prices are only
indications of market values and are subject to change.

2015 Economic and Market Outlook

15

Stay informed
Our strategists will be following all the latest developments in the news to determine the
potential impact on the U.S. and global economy, the markets, and political events overseas.
There are a number of ways to access our advice and commentary to stay informed about
how developments may affect you financially.

Talk to your Financial Advisor

Visit us on Facebook and LinkedIn

He or she can provide research and advice from


Wells Fargo Advisors as well as review your current
investment strategy and goals and help ensure that
you are prepared to act if anything should change.

On our Facebook and LinkedIn pages, youll find news


and helpful information that help you manage your
money and reflect whats going on around us. Like
us on Facebook and connect with us on LinkedIn.

Commentary and analysis posted daily


Be sure to visit our website for the latest market commentary and economic reports. There youll
find our top economic, market, and investment strategists insights on whats happening today
and how you might prepare for whats ahead. Youll also find videos, investment tools, and other
resources to help you stay fully informed.

Go to wellsfargoadvisors.com/research

This publication is designed to provide accurate and authoritative information regarding the subject matter covered. It is made available
with the understanding that Wells Fargo Advisors is not engaged in rendering legal, accounting, or tax-preparation services. If tax or
legal advice is required, the services of a competent professional should be sought. Wells Fargo Advisors view is that investment decisions
should be based on investment merit, not solely on tax considerations. However, the effects of taxes are a critical factor in achieving
a desired after-tax return on your investment. The information provided is based on internal and external sources that are considered
reliable; however, the accuracy of the information is not guaranteed. Specific questions on taxes as they relate to your situation should
be directed to your tax advisor.
Wells Fargo Advisors is a broker/dealer affiliate of Wells Fargo & Company; other broker/dealer affiliates of Wells Fargo & Company may
have differing opinions than those expressed in this report. Contact your Financial Advisor if you would like copies of additional reports.

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MAY Lose Value

Wells Fargo Advisors is the trade name used by two separate registered broker-dealers: Wells Fargo Advisors, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, non-bank
affiliates of Wells Fargo & Company. First Clearing, LLC is a registered broker-dealer and non-bank affiliate of Wells Fargo & Company. 2014 Wells Fargo Advisors, LLC. All rights reserved.
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