FORECAST. Economic and market. Economy. U.S. equities. Fixed income. International and commodities. Alternatives

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1 November 2014 Economic and market FORECAST A monthly report by our Advisory Services Group Economy The U.S. economy has been slowly improving over the past few years. Nevertheless, voters seemed to be very concerned about job creation and economic growth as well as breaking the partisan gridlock in Washington. The mid-term election results show that voters want the political environment to change. This could be a positive to the U.S. economy and investor sentiment during the next year. Of course, there will still be many challenges with Democrats in control of the White House and Republicans in control of both houses of Congress. This year s mid-term election will not eliminate all the obstacles to progress which have held back the U.S. economy over the past few years of political gridlock. But the opportunities for progress are likely to be better as both parties try to enact legislation that would help them position for the Presidential election in two years. U.S. equities So far, third-quarter earnings results remain aligned with our expectation for $120 in S&P 500 Index operating earnings for calendar 2014, and we carry a year-end 2015 S&P 500 Index target range of 2,150-2,250. Earnings breadth has been particularly strong thus far. We generally expect market performance to tilt toward the cyclically sensitive portions of the economy. Our current overweight sectors remain Information Technology, Industrials and Consumer Discretionary. We recommend an underweight to the traditionally defensive, Utility and Consumer Staples sectors. Fixed income Even though the Doves control the FOMC, it appears likely that short-term interest rates will begin increasing next summer. Our target of 75 bps at year end is under the FOMC s own median estimate of 1.375%, however the midpoint of Fed targets are skewed by several hawkish members who remain in the minority and have an opposing view relative to the Chairwoman. In longer maturities, the interest rate curve has been flattening for over a year-and-a-half. Given that the curve still remains relatively steep, further curve flattening should be expected well into and through the next Fed tightening cycle. International and commodities Much of the recent international market weakness arises from uncertainties about global economic growth and the pace and timing of central bank policy around the world. The Fed s slow policy normalization should continue to support global equities and keep bond returns in the low single (positive) digits. The slow pace of stimulative policies in Europe and Japan argues against a strong divergence in monetary policy and in global markets. Overall, the global expansion continues (and U.S. prospects look best), inflation remains low, and policy differences are evolving slowly. Commodities: The recent selloff in commodities probably exaggerates the slowdown in global economic growth, and we think supply will match better with demand into the coming year. Alternatives In light of the potential for higher interest rates over the next twelve months and incremental volatility returning to equity markets, alternatives continue to offer diversifying return profiles which can help dampen volatility and reduce interest rate sensitivity within a diversified portfolio. Additionally, as we potentially move into the back half of the cycle some alternative strategies may offer methods for taking advantage of greater market dislocations and/or larger realized price differences between related securities. Please see pages 4-6 for important disclaimers

2 Economic and market forecast As of November 6, 2014, unless otherwise noted Economy 2014 latest 2015 year-end forecast Inflation-adjusted GDP rolling four quarters 2.3% 1 2.8% Inflation-adjusted GDP latest quarter percent change annual rate 3.5% 1 Unemployment end of period/latest 5.8% 3 5.4% CPI inflation 12-month average 1.6% 2 1.8% Federal deficit rolling 12 months $0.5 tril. 2 $0.4 tril. Existing home sales (SAAR*) end of period/latest 5.2 mil mil. Total vehicle sales (SAAR*) end of period/latest 16.4 mil mil. U.S. equity 2014 latest 2015 year-end forecast S&P 500 index latest 2, ,150-2,250 S&P operating earnings latest (trailing four quarters) $117.00/shr. $128.00/shr. S&P 500 price/earnings trailing four quarters operating earnings Fixed Income 2014 latest 2015 year-end forecast Target federal funds rate latest 0.09% 0.75% 10-year Treasury yield latest 2.39% 3.00%-3.50% 30-year Treasury yield latest 3.10% 3.50%-4.00% International, commodities and currency 2014 latest 2015 year-end forecast MSCI EAFE index latest 1, ,950-2,050 MSCI Emerging Markets index latest ,050-1,130 Oil (per barrel) latest $77.91 $97.00-$ Gold (per troy ounce) latest $1, $1,150-$1,250 U.S. dollars per euro latest $1.24 $1.22-$1.26 * SAAR = Seasonally adjusted annual rate 1 = Data as of third-quarter = Data as of September = Data as of October 2014 Sources: Bloomberg, Wells Fargo Advisors Page 2 of 6

3 Recommended portfolio weightings As of November 6, 2014, unless otherwise noted Equity sectors Overweight Evenweight Underweight Consumer Discretionary Energy Consumer Staples Industrials Financials Utilities Information Technology Health Care Materials Source: Wells Fargo Advisors Telecom Asset classes Overweight Evenweight Underweight International developed stocks Cash alternatives International developed fixed income U.S. large-cap stocks Commodities Long-term investment grade bonds Emerging-market stocks High-yield securities Intermediate-term investment grade bonds International emerging fixed income REITs Short-term investment grade bonds U.S. mid-cap stocks U.S. small-cap stocks Source: Wells Fargo Advisors - Treasuries, agency securities, mortgage-backed securities, corporate bonds and municipal bonds. Fixed income Overweight Slight overweight Evenweight Slight underweight Underweight Duration Agency securities U.S. Treasuries Slightly short * Corporate bonds Mortgage-backed securities Municipal bonds Preferred securities Treasury Inflation- Protected Securities Source: Wells Fargo Advisors * We recommend a duration slightly short of an investor s target duration. If an investor does not have a target duration, then we recommend a duration of approximately 4.75 years in taxable portfolios, and 7.25 years for tax-exempt portfolios. Duration, stated in years, can be used to estimate the percentage change in a bond s value that results from a 1% change in interest rates. The longer (higher) the duration, the more prices will fluctuate as interest rates rise and fall. Page 3 of 6

4 Important Information Definitions An index is unmanaged and not available for direct investment. The S&P 500 Index consists of 500 industrial, financial, utility and transportation companies with market capitalizations of $3 billion or more. The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & 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. The 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. Consumer Price Index (CPI) is a measure that examines 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. Short-term Fixed Income: Fixed Income instruments that mature in one to six years. Intermediate-Term Fixed Income: Fixed Income instruments that mature in six to 12 years. Long-Term Fixed Income: Fixed Income instruments whose maturities are greater than 12 years. International Fixed Income: International fixed income securities (bonds) include any type of fixed income investment made in financially established markets outside of the U.S. These instruments may be denominated in U.S. dollars or in foreign currencies. Bonds are promissory notes and usually make a series of interest payments followed by a return of principal at maturity. If sold prior to maturity, the price that can be obtained for a bond may be more or less than face value, depending on interest rates at the time the bond is sold and the remaining term of the bond. High Yield: Non-investment grade fixed income securities (rated Ba1 or lower by Moody s and/or BB+ or lower by S&P). These investments are considered to be speculative and are subject to a higher degree of risk. International: Financial markets in developed economies outside of the U.S. Emerging Markets: Financial markets in countries with developing economies. These markets are typically immature compared to those of the world s major financial centers but are becoming increasingly sophisticated and integrated into international markets; they provide potentially higher returns but are intensely volatile. REITs: Real estate investment trust (REITs) trade on the major exchanges and invest in real estate directly, either through properties or mortgages. Large-Cap Growth: Stocks that have a market cap greater than $12.5 billion and a price-to-book ratio greater than 2.7. Large-Cap Value: Stocks that have a market cap greater than $12.5 billion and a price-to-book ratio less than or equal to 2.7. Mid-Cap Growth: Stocks that have a market cap between $3.0 - $12.5 billion and a price-to-book ratio greater than 2.7. Mid-Cap Value: Stocks that have a market cap between $3.0 - $12.5 billion and a price-to-book ratio less than or equal to 2.7. Page 4 of 6

5 Important Information Small-Cap Growth: Stocks that have a market cap less than $3.0 billion and a price-to-book ratio greater than 2.7. Small-Cap Value: Stocks that have a market cap less than $3.0 billion and a price-to-book ratio less than or equal to 2.7. Commodities: 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. Duration is a measure used to determine a bond/s or bond portfolio s sensitivity to movements in interest rates. Generally, the longer the duration the more sensitive a bond or bond portfolio is to changes in interest rates. Disclaimers 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. Past performance is no guarantee of future results. Alternative investments may employ more complex strategies, investments, and portfolio structures. In doing so, some of these strategies may expose investors to additional risks, including but not limited to the following: short selling, leverage risk, counterparty risk, liquidity risk, commodity price volatility risk, and/or managed futures roll yield risk. The prices of small and mid-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. Technology and Internet-related stocks, especially of smaller, less-seasoned companies, tend to be more volatile than the overall market. There are special risks associated with investing in preferred securities. Preferred securities generally offer no voting rights with respect to the issuer. Preferred securities are generally subordinated to bonds or other debt instruments in an issuer s capital structure, subjecting them to a greater risk of non-payment than more senior securities. In addition, the issue may be callable which may negatively impact the return of the security. Preferred dividends are not guaranteed and are subject to deferral or elimination. 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). 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. 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. All fixed income investments may be worth less than original cost upon redemption or maturity. Although Treasury Inflation-Protected Securities (TIPS) are considered free from credit risk, they are subject to other types of risks. These risks include interest rate risk, which may cause the underlying value of the bond to fluctuate, and deflation risk, which may cause the principal to decline and the securities to underperform traditional Treasury securities. TIPS have special tax consequences, generating phantom income on the inflation compensation component of the principal. A holder of TIPS may be required to report this income annually although no income related to inflation compensation is received until maturity. The yield, average life and the expected maturity of mortgage-backed securities are based on prepayment assumptions that may or may not be met. Changes in prepayments may significantly affect yield, average life and expected maturity. Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets. Page 5 of 6

6 Important Information Investments in the energy sector are subject to the adverse economic events within that industry. A downturn in the energy sector of the economy, adverse political, legislative or regulatory developments or other events could have a large impact on a portfolio s investments in this sector. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks. Real Estate investments have special risks, including possible illiquidity of the underlying properties, credit risk, interest rate fluctuations, and the impact of varied economic conditions. Wells Fargo Advisors is not a tax or legal advisor. Additional information available upon request. Past performance is not a guide to future performance. The material contained herein has been prepared from sources and data we believe to be reliable but we make no guarantee as to its accuracy or completeness. This material is published solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or investment product. Opinions and estimates are as of a certain date and subject to change without notice. Investment and Insurance Products: NOT FDIC Insured NO Bank Guarantee 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 Member SIPC is a registered broker dealer and non-bank affiliate of Wells Fargo & Company Wells Fargo Advisors, LLC. All rights reserved. CAR Page 6 of 6

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