Economic

& Capital
Markets
Outlook
BNY MELLON INVESTMENT
STRATEGY & SOLUTIONS GROUP
THIRD QUARTER 2015

PREPARED FOR INSTITUTIONAL INVESTORS,

PROFESSIONAL CLIENTS, OR OTHER QUALIFIED,
SOPHISTICATED INDIVIDUALS ONLY.

Executive Summary
ISSG CMC SUMMARY ASSET ALLOCATION
Global Equities
Global Bonds
Cash

Current Benchmark
59.3%
50%
40.7%
50%
0%
0%

Slight reduction in equity overweight ahead of US rate hikes.

Remain overweight Europe Ex-UK as Greek contagion risk appears low.

FIVE THINGS TO WATCH IN Q3 2015

1) Greek contagion in relation to improving European fundamentals.
2) Impact of a slowing Chinese economy in relation to PBOC stimulus.
3) Continued improvement in US economic data ahead of rate hikes.
4) Emerging market corporate debt defaults and bankruptcies.
5) Upside inflation surprises.

FIG. 1: GLOBAL ASSET PERFORMANCE

% change over 3 months to 30 Jun 15
Oil
Japan Equities
Commodities
EM Equities
Global EM Debt (Local Curr.)
US Equities
Global Natural Resource Equities
US Cash
Global EM Debt (USD)
US Dollar
Global Equities
Global High Yield Bonds
Gold
Global Sovereign Bonds
UK Equities
Global Corporate Bonds
Europe ex UK Equities
Developed REITS
-14

-10

-6

-2

10

14

Percentage
Source: Thomson Reuters Datastream & ISSG

ABOUT THE INVESTMENT & STRATEGY SOLUTIONS GROUP

The BNY Mellon Investment Strategy and Solutions Group (ISSG) partners with
clients to develop thoughtful and actionable solutions to broad investment policy
issues. We engage in an ongoing dialogue with our institutional clients to achieve
a deep understanding of their concerns and needs. Harnessing the full depth and
breadth of our global network of specialized investment boutiques across all asset
classes and return/risk objectives, we help craft comprehensive strategies relevant
for our clients specific investment objectives and policies.
The ISSG Capital Markets Committee (CMC) governs asset allocation policy and
assesses the market outlook for the global multi-asset strategies and solutions
managed by ISSG.

What we are watching

Theme

ISSG View

Global
Growth

With growth prospects increasingly

synchronised across developed markets,
the pace of growth has remained sluggish
against a backdrop of tepid business
confidence. EM growth remains soft and
will continue to face headwinds from the
rise in capital costs as policymakers look to
start fiscal tightening in H2 2015.

Global
Inflation

Risks to View

Recent Considerations For

ISSG View

Valuations and expectations are

increasingly sensitive to economic
fundamentals, driving an increase
in asset price volatility that we
expect will continue into 2016.

Developed market policy

mistakes may derail the fragile
growth trajectory, as rapidly
shifting market sentiment raises
the probability of sharper asset
price corrections.

The developed market

employment landscape continues
to show signs of improvement. We
expect this will continue and
provide a tailwind to consumer
sentiment and ultimately
spending. This trend will continue
to be supported by the weakness
in oil and other commodities.

Softness in headline inflation should

continue through H2 2015 as commodity
price and core DM currency weakness
(driven by QE programs) continue to feed
disinflationary pressures. However,
midterm inflation expectations in both the
US and Europe have moved towards
policymaker targets, while risks of outright
deflation have diminished.

Subdued inflation should continue

to feed through to real wage
increases in H2 2015, providing a
tailwind to consumer sentiment in
DMs. Commodities prices appear
to be nearing a bottom, a positive
development for commoditydependent economies.

Wages may start to rise in

some DM economies as labor
market slack diminishes,
driving a pickup in the core
inflation and ultimately
accelerating the path of datadriven policy.

Oil prices will continue to struggle

to make significant gains as
battles for market share and US
shale producers (increasingly
viewed as the supplier of last
resort) ensure strong supply.
Irans return to oil markets would
be a further headwind.

DM monetary policy is continuing to drive a

divergence in central bank balance
sheets as monetary conditions should
remain easy into 2016. Policymakers
continue to struggle to respond to
diverging global monetary conditions
against the context of local economy
activity levels, particularly in EM.

QE in Europe has
improved bank lending
conditions and provided
some additional buffer for
events playing out in
Greece. Currency moves
played a heightened role in
the low return environment
experienced in H1 2015.

With the Fed and markets

increasingly focused on US
policy tightening, herding
risks will remain elevated into
2016 and FX volatility spikes
are likely. Policy
communication will be key to a
smooth exit for the Fed.

Markets continue to view

policymakers globally as the
ultimate put option on a tail risk
event, expecting policy to be
calibrated (and communicated)
to preserve the recovery and
stability in markets.

Scope for incremental fiscal policy in DMs

remains limited, with ongoing budget
deficits and elevated debt/GDP levels
already a concern with investors and the
prospect of a rising rate environment only
increasing the debt servicing burdens.
Renewed focus on trade agreements
could provide longer term growth
opportunities in the event that
negotiations are successfully concluded.

DM fiscal policy responses remain

limited in most cases, with Japan
the exception in maintaining a
steady fiscal policy in the near
term, whilst most other DMs
considering or implementing fiscal
tightening programs. Fiscal policy
more likely to provide headwinds
to asset prices in H2 2015.

Monetary policy continues to

drive a covert currency war
in which export market share
is transferred between
economies and limited new
growth is generated in the
process. Excessive fiscal
tightening in a short period
may derail the growth trajectory
in DMs.

China increasing use of monetary

and fiscal policy tools to offset
concerns around slowing growth,
disinflationary pressures, and
asset prices, a trend likely to
continue in H2 2015. US now
in position to pursue trade
agreements (Trans Pacific
Partnership) which could
significantly impact
international trade in 2016 and
beyond.

Emerging
Markets

Tightening monetary policy in the US has

largely been a negative for EM assets, and
while some respite has been provided
through EU and Japan QE programs, the
stronger USD and rising cost of capital will
continue to weigh on EM sentiment; recent
disinflationary pressures have provided
some scope of accommodative policy in
selected EMs.

Though attractive on a relative

valuation basis vs DM assets,
several markets remain vulnerable
to an acceleration in capital
outflows and would be further
affected in the event of monetary
tightening if central banks are
required to step in to support local
currencies.

Attractive valuations and

prudent policy drive an
acceleration in growth and
EM asset outperformance in
certain parts of the EM
investment universe.

The EM universe will remain

highly differentiated into 2016 as
growth, inflation and policy
dynamics continue to diverge.
Watch for signs of an uptick in
commodity prices, which may
provide a growth catalyst for EMs.

"Tail Risk
Monitor"

Grexit a distinct possibility in H2 2015,

with growing concerns around the second
order effects in in both Europe and more
widely across global markets. Rapidly
rising European rates, driven by rising
inflation expectations, may further
complicate the reconciliation of the ECBs
QE program against its price stability
mandate. Russia-Ukraine conflict
continues to simmer and could re-emerge
in H2 2015.

Low yield, rising rate

environment complicating the
choice of flight to safety assets,
with potential capital losses on
bonds likely to erode yield
pickup; USD the most likely
candidate for the risk off trade
in H2 2015 as investors
increasingly de-risk through
cash allocations.

Grexit drives a period of

heightened volatility across
European assets, with other
small economies still
recovering from the global
financial crisis facing
increased financing costs
and even weakening
political support for fiscal
adjustment programs.

Liquidity in fixed income markets,

whilst widely cited as a known
issue, has yet to be tested through
a prolonged sell-off period. EM
refinancing of dollar based
corporate and sovereign debt
could start to reveal pressure
points in H2 2015.

Monetary
Policy

Fiscal Policy

Asset Class Impact

Key Charts: Economics And Markets

EUR 5Y/5Y Inflation Swap Rate
%

Fig. 2: Inflation finally coming to the eurozone?

2
1.9
1.8
1.7
1.6
1.5
1.4

Figure 2 Source: Bloomberg, December 2014 June 2015

Fig. 3: Depletion of Greek bank deposits

240
220
billion

Entering 2015, deflation was a significant concern for

investors, especially in Europe. With the steps taken by
the ECB early in the year and resulting impact on the
euro, inflation expectations seem to be on the rise. While
this is a welcome sign, continued improvement in
economic data, especially youth unemployment, will be
more critical to the Euro region. The move thus far in
European markets has been more a reduction in the
probability of deflationary worst case scenario rather than
an acknowledgement of better than expected outcomes
still to come.

200
180
160
140

The run on Greek banks illustrates as well as any chart,

in our opinion, the challenge the Greeks face in getting
their economic house in order. We continue to believe
that the direct financial impact of Greece is limited given
its small relative size to both the eurozone and global
economies. The contagion risk takes the form of an
erosion in the political confidence in the euro should
Greece leave the currency bloc and as a result inspire
other countries to do the same. We are also concerned
with the general level of uncertainty around whether a
Greek exit from the euro would prove to be disorderly.

120
Figure 3 Source: Bloomberg; May2009 May 2015

% of GDP

Fig. 4: US cost cuts crowding out capital expenditures?

18%
16%
14%
12%
10%
8%
6%
4%
2%
0%

Corporate Profits

Capex

Renminbi / Yen Cross Rate

Fig. 5: Regional currency headwinds for Chinese economy

22
20
18
16
14
12

With US equity markets at all time highs and squarely in

fair valuation territory, many investors are looking for the
catalyst that keeps the economic cycle going. Put another
way, the question is are we mid-cycle or late-cycle?
They key to the sustainability of the US economic cycle,
to us, comes in the form of capital spending by the private
sector to drive the next phase of the current market. If
liquidity and cost cutting have driven the first half,
investment and economic productivity will need to drive
the second.

Figure 4 Source: Bloomberg; December 1980 March 2015

Currency trends have been significant forces moving

markets in 2015 and will remain so in the future. Asia sits
at the epicenter of global currency trends and should be
watched very carefully in the near future. The recent
depreciation in the yen challenges the classic export-led
stimulus playbook for China, especially given its soft peg
to a basket of currencies including a strengthening dollar.
At the same time, China wants the RMB to become a
reserve currency which will require stabilization of value.
How these opposing forces play out will be extremely
important to both Asian and global markets.

10

Figure 5 Source: Bloomberg; January 2006 June 2015

ISSG Global Heatmaps

Fig. 6: ISSG Global Macroeconomic Heat Map

This heat map is designed to display a wide spectrum of macroeconomic trends across the major global regions over the past three years. Green and red shading indicate what
we believe to be positive and negative levels, respectively, of the indicated variables; while green and red borders indicate positive and negative changes over the last quarter.
Yellow shading indicates neutral readings. The time series lines are shown merely for ease of comparing trends, and are not meant to convey any particular values or levels.
See appendix for series definitions and sources.

The ISSG Heatmaps (Fig 6) show several new trends since last quarter. Economic surprises in the US, combined with
positive trends in company earnings suggest the first quarter slowdown was weather-related as opposed to something more
secular. The rise in US company earnings indicates an easing of currency pressure on global companies thanks to the
recent pause in dollar strength. Inflation in Europe has started to surprise to the upside and indicates that the QE program
launched by the ECB earlier in the year is beginning to create inflationary pressure in the eurozone. Finally, a key trend we
believe bears watching is in China where monetary policy has become loose given recent actions by the PBOC and yet
there are still negative economic surprises compared with last quarters indicator.
Fig. 7: ISSG Global Correlation Heat Map

The Global Correlation Heatmap is designed to convey levels and changes in correlation and volatility numbers across major asset classes. Numbers in the unshaded cells
represent the current exponentially weighted volatility level, with green and red fonts representing low and high levels relative to a time-weighted 3 year mean. The lower left half
of the Heatmap, displaying exponentially-weighted weekly correlation pair data for the last 3 years, is included to allow users to compare trends and is not meant to convey any
particular values or levels. The upper right half of the Heatmap reflects the current observation for the same data series. Green and red shading indicate what we believe to be
low and high levels, respectively, of the current observation relative to a time weighted 3 year mean, while green and red borders indicate a significant decrease or increase
over the last quarter.

This quarters Global Correlation Heatmap (Fig 7 shows a continuing decline in correlations between commodities and
equity markets, especially EM equity markets. This supports the thesis that excess supply is present across many
commodity markets as a result of the recent end of the commodity super-cycle. We believe the downward trend in
correlations will remain in place due to the combination of excess capacity, and an approaching rate hike cycle in the US
that will provide continued strength to the dollar, while changing demand trends in global markets. Dollar volatility has
increased since last quarter, reflecting both general currency volatility in global markets as well as some degree of
uncertainty around both the start and pace of approaching US rate hikes.
5

Economic Outlook
Needless to say, 2015 has been quite an interesting year thus far.
The announcement and implementation of quantitative easing
from the European Central Bank early in the year has helped to
alleviate the fear of deflation that hung over the region coming into
2015. Beyond the actions of the ECB, the surprising Greek
election gave the Syriza party additional influence based on their
anti-austerity platform. The impact of the election is still being felt
throughout European and global markets as Greece deals with
rising debt. Meanwhile, currency has remained a significant factor
for global investors with the impact probably best shown by the
unexpected de-pegging of the Swiss franc from the euro. Finally,
China has also been a focus for investors in the first part of the
year and we expect it to remain so for the foreseeable future as
Beijing addresses an economic slowdown and severe market
turbulence.
The fireworks from the first part of this year have created some
interesting trends in the global growth outlook (Fig 8). The impact
of severe weather in the US in the early part of the year coupled
with Chinas continued economic slowdown have prompted
continued negative revisions to global growth expectations.
Despite those revisions, concerns over a more severe slowdown
in the US appear to be easing and expectations of a second half
acceleration are increasing. Economic indicators continue to
improve from the first part of the year which was depressed due to
severe weather.

Fig. 8: Expected Global Growth and Growth

Revisions
Global 12M GDP Revisions

Global 12M Expected GDP Growth

6%
4%
2%
0%
-2%
-4%
-6%

Fig. 9: Expected Global Inflation and Inflation

Revisions
Global 12M Inflation Revisions
Global 12M Expected Inflation
6%
4%

As mentioned previously, there has been an increase in inflation

expectations in the Eurozone (Fig 10) that indicates economic
traction of the ECBs stimulus program. While the positive
revisions to expectations in the BRICs is a welcome sign,
significant concerns remain in relation to Brazil, China, and Russia.
Brazil and Russia both rely heavily on external funding and
commodity based flows, while China continues to slow despite
recent actions by the PBOC. Japan continues to benefit from
Abenomics with recent economic data being better than
expected despite the negative revisions to both growth and
inflation. The recent depreciation in the yen is providing support to
inflation expectations as are positive wage increases in the
country.

2%
0%
-2%
-4%

Fig. 10: Quarterly Regional Revisions For

Growth and Inflation
3M Change in GDP & CPI Revisiosn Index

Our chart of expected inflation (Fig. 9) reveals a stabilization in the

recent steep decline in both expected levels of inflation and
revisions to inflation expectations. Indeed, expected inflation is
actually turning upwards. The stabilization in energy prices has
helped to support the positive turn in inflation expectations as
have wage pressures in the US. But the recent increase in
European inflation expectations has been more surprising, despite
concerns over the impact of a Greek default and possible exit from
the euro, or Grexit. Looking forward, the continued increase in
inflation expectations and improvement in underlying economic
fundamentals throughout the region, beyond Greece, will be
critical for determining the path of both European and global
markets.

0.5%
0.4%
0.3%
0.2%
0.1%
0.0%
-0.1%
-0.2%
-0.3%
BRICs

Eurozone

GDP

US

Japan

CPI

Source for Fig. 8,9,10: Consensus Economics, ISSG

Fig. 11: Global Headline Hotlist

The above graphic shows the top ten most mentioned themes that
are relevant to financial markets in order of their ranking on July 2,
2015. The bar height shows the frequency of the coverage of each
theme in the news for each of the last 13 weeks, with the furthest
right bar representing the most recent ranking. The color of the
background denotes the average intensity over the past quarter.
Using financial media and influential blogs identified by multiple
teams at BNY Mellon, those stories are used to highlight the hottest
topics each week across over 3,000-6,000 news items. Story
summaries are classified using a Bayesian classifier which is trained
on stories from the last six months. Training stories are manually
tagged and classified by a senior strategist.

Fig. 12: RBAA* Regime Probabilities

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

Source ISSG as of 30 June 2015.

This quarters Global Headline Hotlist (Fig. 11) reveals an interesting

change as the Q2 list did not include a single headline related to
Europe or European markets. What a difference three months can
make with this quarters list being dominated by European headlines
given recent issues with Greece and its ability to service debt
obligations to the Troika made up of the IMF, ECB, and European
Commission (EC). Much attention has been given to the threat of a
debt default by Greece and its possible expulsion from the euro
currency bloc. Our view on Greece is that political contagion in the
region is the bigger concern rather than direct financial or economic
contagion.
With Greeces contribution to the overall GDP of the EU coming in at
just over 1% in 2014, the direct financial impact of a Greek default and
exit from the euro currency would be limited. The intangible
reverberations are the bigger concern in our opinion. With several
nationalist movements gaining traction throughout the region, such as
Scottish independence in the UK and Podemos in Spain to name just
two, a Greek exit from the euro could add further positive momentum
to these movements by showing that exit from the euro is not only
plausible but also possible. As a result, political confidence in the
euros sustainability becomes a much bigger risk to global markets due
to the amount of uncertainty created in global currency markets. As
events in Greece continue to play out in the coming weeks and
months, key indicators to watch for will be any signs of contagion in the
form of non-Greek sovereign yields, especially in peripheral countries,
implied volatility indicators globally, and global credit spreads with a
focus on lower quality spreads.
As noted earlier, inflation expectations in many parts of the world have
started to stabilize and even turn higher. This trend is further confirmed
by the recent increase in the probability of a warming regime, not to
mention an increase in the probability of a too hot regime from 0% to
5% (Fig. 12). The stabilization in energy prices has provided a floor to
inflation expectations. In addition, increasing wage pressures in the US
from a tighter labor market provides further upward pressure. At the
same time, implied volatilities continue to be sanguine on a relative
basis and the yield curve remains steep and supportive of continued
lending. All this comes while rates are at all time lows and the Fed has
indicated future rate hike but has yet to act. Ironically, and in contrast
to the beginning of the year, the threat appears to have shifted from
deflation to inflation whereby inflation begins to be reported ahead of
expectations.
As we have noted in past commentaries, we continue to watch the
credit complex carefully for signs of distress given the recent volatility
in yields. With regulatory changes in Europe driving lending from bank
to non-bank sources combined with the emergence of emerging
market corporate debt in recent years, any disturbance in the flow of
credit to non-US companies could present significant headwinds to
markets. Substantial amounts of refinancing will need to take place in
the near to medium term and the cost of debt financing relative to
company fundamentals in both European and EM corporate sectors
will be one of the most important interplays to support a continued
global economic expansion.

*Regime Based Asset Allocation (RBAA) is a proprietary asset allocation model created by the ISSG which considers asset returns in the context of regimes created by underlying
changes in growth and inflation expectations. Contact the ISSG for detailed information on this research. Please see appendix for information regarding regime categories.

Asset Class Outlook

Fig. 13: ISSG CMC Global Asset Class Views
Global Equity Markets:
ISSG CMC
View
Overweight

US Equity

Favorable

Favorable

Favorable

Favorable

Favorable

Favorable

Neutral

Neutral

Unfavorable

Japan remains one of the best performing markets year to date, even
considering the recent yen depreciation. Wage negotiations have
started to lead to wage increases and consumer spending is beginning
to increase as the prior fiscal tightening moves further into the past.
Yen depreciation is supporting export competitiveness as well.
Neutral

UK Equity

Favorable

The region remains highly sensitive to expectations for Chinese

economic growth as well as further policy stimulus from the PBOC.
Uncertainty around Chinese economic growth and its impact keep us
neutral.
Overweight

Japan Equity

Favorable

RBAA
Model

We remain overweight to Europe Ex-UK despite increasing concerns

over a Greek default and possible Grexit. The depreciation in the
euro has served as a positive catalyst and the ECB maintains its
accommodative stance to the region. Inflation expectations are moving
higher and fundamentals are improving.
Neutral

Pacific exJapan Equity

Favorable

Momentum
Model

We remain overweight to the US but continue to reduce the size of the

overweight position as valuation moves squarely into fair territory.
Underlying economic data continues to be positive. Uncertainty around
both the start and pace of rate hikes in the US remains the major
question and justifies a reduction in overweight.
Overweight

Europe ex-UK
Equity

Valuation
Model

Favorable

Neutral

Favorable

The decisive results of the May elections have removed an underlying

uncertainty from the UK markets but created another with David
Camerons call for a referendum on EU inclusion coming as soon as
2016.

ASSET CLASS

ISSG VIEW

Global Equities

+9.3%

U.S.

O/W

Europe Ex U.K.

O/W

Pacific Ex-Japan

Neutral

Japan

O/W

U.K.

Neutral

EM

Neutral

REITS

Neutral

Global Natural Res.

Neutral

Global Bonds

-9.3%

U.S. Sovereign Debt

U/W

U.K. Sovereign Debt

U/W

Japanese Sovereign Debt

U/W

German Sovereign Debt

U/W

High Yield

Neutral

U.S. IG Corp. Bonds

Neutral

EM Local Cur. Debt

O/W

EM USD Sovereign Debt

Neutral

Cash

+0.0%

Fig. 14: Global Equity Index Performance

% change over 3 months to
30 Jun 15
EM
World Small Cap
World Growth

Neutral
EM Equity

Favorable

Favorable

Favorable

We have moved to a neutral position in emerging markets. The

combination of a slowing China, despite policy stimulus, with the risk of
capital flows out of the asset class due to increasing interest rates in the
US create significant headwinds. Beyond China, the threat that Brazil
poses to global markets is significant.

World Large Cap

World
World Value
-0.5

0.5

1.5

Neutral
REIT Equity

Neutral

Global Natural
Resource
Equity

Favorable

Unfavorable

Favorable

With momentum in the asset class turning negative given the move
higher in global yields, previous valuation excesses of REITs have been
alleviated and we move to a neutral weighting in the asset class. We
are watching the momentum component closely given the threat of
rising rates.
Favorable

Neutral

Unfavorable

We continue to believe that secular forces in the form of a stronger

dollar and excess capacity will create a ceiling to the overall commodity
complex. A transition away from fixed capital formation in China will
also serve to alter future supply demand dynamics as will the outright
slowdown in the country. We believe a fundamental and active
approach in the natural resource equity complex will provide
opportunities through alpha capture given increased commodity
dispersion and weather related volatility.

Source: Thomson Reuters Datastream & ISSG

Fig. 15: Country Index Performance %

change over 3 months to 30 Jun 15
China Equity
Japan Equity
Brazil Equity
US Equity
India Equity
France Equity
UK Equity
Australia Equity
Germany Equity
-10

-8

-6

-4

-2

0
%

Source: Thomson Reuters Datastream & ISSG

Global Bond Markets:

Fig. 16: Fixed Income Performance

% change over 3 months to 30 Jun 15

ISSG CMC
View

Leveraged Loans
Global EM Debt (Local Curr.)
Global Inflation Linked Bonds

High Yield
Bonds

Neutral
Favorable
Favorable
Unfavorable
The back up in high yield spreads has made the valuation worthy of
moving from our previous underweight position to neutral. Looking at
historical behavior of the asset class, times of recession are most
dangerous for high yield bonds and we do not believe there is a
recession on the horizon for the near to medium term time horizon.
Relative valuation compared with equities merits a neutral stance.

Investment
Grade
Corporate
Bonds

Neutral
Unfavorable
Unfavorable
Unfavorable
We remain neutral weight in investment grade bonds based on a
small back up in spreads in this sector. The spread component of
the asset class combined with the high credit quality keep us neutral.
Investors appear to favor this asset over sovereign bonds for similar
reasons adding to positive momentum and performance in the
sector.

Global Corporate Bonds

-3

-2

-1

Source: Thomson Reuters Datastream & ISSG

Fig.17: Commodities Performance

% change 3 months to 30 Jun 15

Emerging
Markets
Local
Currency
Bonds

Energy
Oil

Emerging
Markets
USD Bonds

Agriculture
Gold
Precious Metals
Industrial Metals

Cash
-6

-4

-2

10

12

RBAA
Model

Developed
Sovereign
Bonds

Global High Yield Bonds

-4

Momentum
Model

Underweight
Unfavorable
Unfavorable
Unfavorable
Volatility in yields has started to increase given their recent rise as
inflation expectations in both the US and Europe start to move
higher. The market consensus for a start to rate hikes in the US
appears to have moved out to September.

Global EM Debt (USD)

Global Sovereign Bonds

Valuation
Model

Overweight
Favorable
Neutral
Neutral
We remain overweight in EM local currency bonds based on
attractive valuations from the movement lower in EM currencies,
especially Asian currencies, relative to recent dollar strength.
Corporate bond defaults bear watching closely.
Neutral
Neutral
Favorable
Neutral
We remain neutral on EM dollar based debt where the valuations are
not as attractive from currency movement as in the local currency
bonds. While absolute yields on both forms of EM debt are
attractive, we believe investors need to monitor developments in the
asset class given pending Greek events and the depth of Brazilian
and Russian recessions relative to expectations.
Neutral
N/A
N/A
N/A
We remain neutral to cash which is a zero weight in our base
portfolio given our favorable view of risk assets. Cash continues to
carry option value in order to de-risk the portfolio should volatility
increase with interest rates still at historic lows.

Commodities:

Source: Thomson Reuters Datastream & ISSG

Neutral
Commodities have made a recovery in the most recent quarter lead
by the energy complex, in particular crude oil. Prices appear to have
stabilized with the oil curve still in contango and a potential nuclear
deal with Iran threatening increased supply, we remain neutral on
the overall commodity complex.

Fig. 18: FX Currency Pairs

% change 3 months to 30 Jun 15
Currency:

JPY/USD

EUR/USD

Underweight
Pending Greek events may add volatility to the currency should
there be an erosion in confidence of the monetary union and as a
result we remain underweight.

JPY/USD

Neutral
Additional yen depreciation has served as a further catalyst for the
Japanese equity markets. Yen depreciation is creating uncertainty
in regional currency dynamics, particularly with the KRW and CNY
that bear watching in the future with a slowing Chinese economy and
export dependent Korea as a backdrop.

EM:
Asia/USD

Neutral
As mentioned above, a weaker yen has changed some of the longer
held currency relationships in the region between exporters and
importers. The CNY continues its pattern of internationalization, a
trend that should be closely followed especially given its soft peg.

EM:
LATAM/USD

Neutral
While we are neutral to the regional currencies, Brazil remains a
threat should their economy fall further into recession and external
funding sources begin to disappear.

IND/USD
CHN/USD
AUD/USD
CAD/USD
BRL/USD
EUR/USD
SEK/USD
RUS/USD
GBP/USD
-6

-5

-4

-3

-2

-1

%
Source: Thomson Reuters Datastream & ISSG

Performance Monitor
Fig. 19 : Capital Markets
% change over 1 year to 30 Jun 15

Fig. 20 : Equity Country Performance Lcl. Crncy.

% change over 1 year to 30 Jun 15

Japan Equities
Developed REITS
US Dollar
Europe ex UK Equities
Global Equities
US Equities
EM Equities
Global EM Debt (Local Curr.)
US Cash
UK Equities
Global EM Debt (USD)
Global Corporate Bonds
Global High Yield Bonds
Global Sovereign Bonds
Gold
Global Natural Resource Equities
Commodities
Oil

Japan Equity
China Equity
France Equity
Germany Equity
India Equity
US Equity
Australia Equity
Brazil Equity
UK Equity
-50 -40 -30 -20 -10

10

20

30

10

15

20

25

30

Source: Thomson Reuters Datastream & ISSG

Source: Thomson Reuters Datastream & ISSG

Fig. 22: Fixed Income Performance

% change over 1 year 30 Jun 15

Fig. 21: Global Equity Performance Lcl. Crncy.

% change over 1 year to 30 Jun 15

Global EM Debt (Local Curr.)

World Growth
Leveraged Loans
World
Global Inflation Linked Bonds
World Large Cap

Global EM Debt (USD)

World Small Cap

Global Corporate Bonds

EM

Global High Yield Bonds

World Value

Global Sovereign Bonds

-5

-4

-3

-2

-1

-8

-6

-4

-2

Source: Thomson Reuters Datastream & ISSG

Source: Thomson Reuters Datastream & ISSG

Fig. 24: FX Currency Pairs

% change 1 year to 30 Jun 15

Fig. 23: Commodities Performance

% change 1 year to 30 Jun 15

RUS/USD
BRL/USD

Gold

SEK/USD
Agriculture

EUR/USD
AUD/USD

Precious Metals

JPY/USD
Industrial Metals

CAD/USD

Energy

GBP/USD
IND/USD

Oil

CHN/USD
-50

-40

-30

-20
%

Source: Thomson Reuters Datastream & ISSG

10

-10

-2

10

16

22

28

34

40

%
Source: Thomson Reuters Datastream & ISSG

46

52

58

64

Appendix & Disclosures

ASSET

INDEX

DEFINITION

Commodities

Bloomberg Commodities Index Total

Return (USD Index)

The Bloomberg Commodities index is an index that tracks the performance of

broad based commodities.

Gold

Gold Bullion LBM USD/ozt

Tracks the performance of gold bullion spot prices.

Oil

Brent Crude Month FOB USD/BBL

Tracks the performance of Brent Crude Oil spot prices.

Global Sovereign Bonds

JPM Global GBI (USD Index)

Tracks the performance of global sovereign bonds.

Developed Sovereigns

US, UK, Japan, and German Sovereign Debt securities

US Equity

S&P 500 (USD Index)

Tracks the performance of 500 of largest market capitalization equities in the United States.

US Cash

JPM US Cash Index (3M) (USD Index)

Tracks the performance of US 3 month treasury bills.

US Dollar

JPM USD Index Real Broad

Tracks the performance of the US Dollar against a basket of broad currencies.

Global Corporate Bonds

Barclays Global Agg Corp (USD Index)

Tracks the performance of aggregate corporate bonds.

Developed REITS

FTSE E/N Dev REITS (Local Currency)

Tracks the performance of global real estate investment trusts in developed markets.

Global Natural Resource Equities S&P Gbl Nat Resource Equities (USD Index) Tracks the performance of global equities linked to natural resources.
Global Investment Grade Bonds

Barclays Inv Grade Corporates (USD Index)

Tracks the performance of aggregate investment grade corporate bonds.

Global Inflation Linked Bonds

Barclays Global Agg Infl-Lkd (USD Index)

Tracks the performance of global inflation linked bonds.

Global High Yield Bonds

Barclays Global High Yield (USD Index)

Tracks the performance of global high yield bonds rates below investment grade.

Global Equities

MSCI World (LC Index)

Tracks the performance of developed market global equities.

MSCI AC World

MSCI AC World Index

Tracks the performance of developed market global equities

Global EM Debt (USD)

JPM EMBI Global Composite (USD Index)

Tracks the performance of dollar based emerging market sovereign bonds.

EM Equities

MSCI Emerging Markets (LC Index)

Tracks the performance of emerging market equities.

UK Equities

FTSE 100 (LC Index)

Tracks the performance of equities domiciled within the United Kingdom.

Europe Ex UK Equities

MSCI Europe ex UK (LC Index)

Tracks the performance of equities domiciled in Europe and not including the UK.

Japan Equity

MSCI Japan (LC Index)

Tracks the performance of equities domiciled in Japan.

Pacific Ex Japan Equity

MSCI Pacific ex Japan (LC Index)

Tracks the performance of equities domiciled in the Asia - Pacific region but not
including Japan.

Germany Equity

DAX 30 (LC Index)

Tracks the performance of 30 of largest equity market capitalization companies in Germany.

Eurozone Equity

EuroStoxx 50 (LC Index)

Tracks the performance of 50 of largest equity market capitalizations in the Eurozone.

France Equity

CAC 40 (LC Index)

Tracks the performance of 40 of the largest equity market capitalizations of France.

Australia Equity

ASX All Ordinaries (LC Index)

Tracks the performance of the largest equity market capitalizations of Australia.

Brazil Equity

MSCI Brazil (LC Index)

Tracks the performance of the equities domiciled in Brazil.

India Equity

MSCI India (LC Index)

Tracks the performance of equities domiciled in India.

China Equity

MSCI China (LC Index)

Tracks the performance of equities domiciled in China.

World Growth

MSCI World Growth (LC Index)

Tracks the performance of growth oriented equities as defined by MSCI.

World Large Cap

MSCI World Large Cap (LC Index)

Tracks the performance of large equity market capitalization companies.

World Value

MSCI World Value (LC Index)

Tracks the performance of value oriented equities as defined by MSCI.

World Small Cap

MSCI World Small Cap (LC Index)

Tracks the performance of small equity market capitalization companies.

Leveraged Loans

S&P Leveraged Loan Index (USD Index)

Tracks the performance of leveraged loans.

Global EM Debt (Local Curr.)

JPM GBI Emerging Markets (LC Index)

Tracks the performance of local currency denominated emerging market bonds.

Agriculture

S&P GSCI Agriculture Total Return (USD Index) Tracks the total return performance of agricultural commodity futures.

Precious Metals

S&P GSCI Precious Metals Total Retn

Tracks the total return performance of futures for precious metals related futures.

Industrial Metals

S&P GSCI Industrial Metals Total Retn

(USD Index)

Tracks the total return performance of futures for industrial metals related commodities.

Energy

S&P GSCI Energy Total Return (USD Index)

Tracks the total return performance of futures for energy related commodities.

EUR/USD

EUR/USD

Tracks the performance of the Euro / US Dollar exchange rate.

RUS/USD

RUS/USD

Tracks the performance of the Russian Ruble / US Dollar exchange rate.

CHN/USD

CHN/USD

Tracks the performance of the Chinese Renminbi / US Dollar exchange rate.

SEK/USD

SEK/USD

Tracks the performance of the Swedish Krona / US Dollar exchange rate.

GBP/USD

GBP/USD

Tracks the performance of the British Pound / US Dollar exchange rate.

AUD/USD

AUD/USD

Tracks the performance of the Australian Dollar / US Dollar exchange rate.

11

ASSET INDEX DEFINITION

BRL/USD

BRL/USD

Tracks the performance of the Brazilian Real / US Dollar exchange rate.

CAD/USD

CAD/USD

Tracks the performance of the Canadian Dollar / US Dollar exchange rate.

IND/USD

IND/USD

Tracks the performance of the Indian Rupee / US Dollar exchange rate.

JPY/USD

JPY/USD

Tracks the performance of the Japanese Yen / US Dollar exchange rate.

EM LATAM/USD

Considers the aggregate performance direction of a basket of currencies from Latin

Americia countries as defined in the JPM GBI Emerging Markets Index

EM Asia/USD

Considers the aggregate performance direction of a basket of currencies from Asian

countries as defined in the JPM GBI Emerging Markets Index

EUR FX

Tracks the performance of the Euro / US Dollar exchange rate.

GBP FX

Tracks the performance of the British Pound / US Dollar exchange rate.

JPY FX

Tracks the performance of Japanese Yen / US Dollar exchange rate.

EM FX

Tracks the performance of a basket of Emerging Markets currencies versus the US Dollar.

US 10Y Yield

Tracks the performance of the yield on the 10 year US treasury note.

Inflation
Headline Consumer Price Index
Tracks the performance of inflation as reported by respective national economic
statistics bureaus.
Growth (PMI)
Tracks the performance of purchasing managers indices in each country to proxy
GDP growth.
EUR Inflation Swap Forward 5Y5Y

(Figure 2)

This is a rate commonly used by central banks and dealers to observe the markets future
inflation expectations.

Company Earnings

A proprietary diffusion index of positive and negative analyst earnings estimate revisions.

Monetary Policy
Derived from the futures curve for short term interest rates as indicative of central
bank policy.
Inflation Revisions

A proprietary measure of cumulative economist revisions for future levels of inflation

in a country.

Growth Revisions

A proprietary measure of cumulative economist revisions for future real economic growth
in a country.

Greek Bank Deposits (Figure 3)

Tracks the level of total demand deposits in the Greek banking system.

TODETOGR index

Corporate Profits (Figure 4)

CPFTTOT

Tracks income that corporations earn from current production. It is normally measured
before income taxes.

Capex (Figure 4)

Nonfinancial business capital expenditures fixed investment.

NFIBFCAP

GDP (Figure 4)
GDP CUR$
Measures final market value of all goods and services produced within a country in
nominal dollars.
Renminbi / Yen Cross Rate (Figure 5)

Tracks the cross rate between the Chinese Renminbi and the Japanese Yen.

Dollar (Figure 7)

Tracks the performance of the US dollar against a basket of global currencies.

Bloomberg US Dollar Index

(DXY Index)

DM Bonds
JPMorgan GBI Global Unhedged LC

Tracks the performance of non-US developed market investment grade corporate bonds
denominated in local currency.

These benchmarks are broad-based indices which are used for comparative purposes only and have been selected as they are well known and are easily recognizable by investors. Comparisons
to benchmarks have limitations because benchmarks have volatility and other material characteristics that may differ from the portfolio. For example, investments made for the portfolio may differ
significantly in terms of security holdings, industry weightings and asset allocation from those of the benchmark. Accordingly, investment results and volatility of the portfolio may differ from
those of the benchmark. Also, the indices noted in this presentation are unmanaged, are not available for direct investment, and are not subject to management fees, transaction costs or other types of
expenses that the portfolio may incur. In addition, the performance of the indices reflects reinvestment of dividends and, where applicable, capital gain distributions. Therefore, investors should carefully
consider these limitations and differences when evaluating the comparative benchmark data performance. The foregoing index licensers are not affiliated with The Bank of New York Mellon Corporation,
do not endorse, sponsor, sell or promote the investment strategies or products mentioned in this presentation and they make no representation regarding advisability of investing in the products and
strategies described herein. Valuation Model The ISSG Valuation Model considers relative valuations across the asset classes that we rank. We consider the current values placed on future
cash flows of the securities against their historical longer-term trend levels. Momentum Model The ISSG Momentum Model considers relative price momentum across the asset classes
that we rank. Our research shows that this can be an indicator of continued appreciation potential in the future. RBAA Model The ISSG Regime Based Asset Allocation Model defines five
macroeconomic regimes based on the interaction of growth and inflation expectations. We believe changes to these expectations drive regime shifts and influence asset returns.

BNY Mellon ISSG RBAA Regimes:

CORRELATION HEAT MAP DEFINITIONS

GROWTH

s
WARMING

COOLING
TOO HOT
TOO COLD

s
12

INFLATION

PERFECTION

ASSET CLASS
World Equity
EM Equity
DM Bonds
EM $ Bonds
DM IG Corps Hedged
DM HY Corps Hedged
Commodities
Dollar

INDEX please see above for definitions

MSCI AC World (LC Index)
MSCI Emerging Markets (LC Index)
JPMorgan GBI Global Unhedged
JPMorgan EMBI Global Composite (USD Index)
Barclays Global Aggregate Corp Index (USD Index)
Barclays Global High Yield (USD Index)
Dow Jones UBS Commodities Index Total Return (USD Index)
US Dollar Index

For more information, please contact:

GENERAL INQUIRIES & AMERICAS

Stephen Kolano, CFA
Investment Strategist
617.722.3995
stephen.kolano@bnymellon.com

APAC
Chris Harris, CFA
Investment Solutions Strategist
+81.3.6756.4637
chris.harris@bnymellon.com

EMEA
Ivo Batista, CFA
Portfolio Strategist
+44.20.7163.5475
ivo.batista@bnymellon.com

CFA and Chartered Financial Analyst are

registered trademarks owned by CFA Institute.

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