HOUSE_OVERSIGHT_014558.jpg

Overweight US Energy Infrastructure Master Limited Partnerships (MLPs): We initiated a direct allocation to energy MLPs in late January 2016 and have maintained that tilt. Given our assumptions about oil prices, we believe that the cash distributions from MLPs are generally secure and provide a yield to investors of just over 7%. In the absence of any valuation changes, the yield translates into a high single-digit tax-advantaged return. Any growth in cash flow distribution or improvements in valuation relative to the S&P 500 would provide some upside. Overweight Spanish Equities: We maintain an overweight to Spanish equities on a currency- hedged basis. This tactical tilt was introduced in August 2013, and we have adjusted the size of the overweight about a dozen times since. Spanish equities offer some of the cheapest valuations across the developed markets, attractive dividend yields, expected earnings growth of 4.6%, aided by healthy domestic growth, and a particularly well-capitalized®* banking sector that has a lower nonperforming loan ratio than the Eurozone bank average. Furthermore, Spain is unlikely to face the same political uncertainty as Germany, France and Italy in 2017. We expect high single-digit returns for Spanish equities. Short Five-Year German Bunds: We recommend a short position in five-year German bunds as the ECB embarks upon the process of shifting its monetary policy. After the December 2016 meeting, the ECB announced that it would reduce its monthly purchases of bonds from €80 billion to €60 billion starting in March 2017 and continuing through December 2017. We expect the ECB to end all purchases sometime in 2018, barring any shocks. As a result, we think interest rates for Eurozone sovereign debt will rise gradually over the course of the year, which in the case of German bunds means they will become less negative. We expect a modest 2% return from this tilt. Short Chinese Renminbi: We have increased our bearish position on the Chinese renminbi over the course of 2016. China is under pressure from multiple sides: the need for loose monetary policy to achieve the leadership’s 6.5% target GDP growth rate, 32 months of capital outflows that have accelerated in late 2016, a strong dollar and an incoming Trump administration that will likely pursue a US-centric policy toward China. Risks are exacerbated by the leadership’s lack of experience in handling financial market volatility, as evidenced by China’s policy response to its equity market collapse in June 2015 and its approach to shifting the currency regime to a more flexible one in August 2015 and January 2016. We expect the currency to depreciate about 7% in 2017; since 4% is already priced in the forward markets, we expect a return of about 3%. There is considerable scope for further upside from this tilt if China abandons its current control of the currency, a move that could lead to depreciation in the renminbi of about 20%. Our tactical tilts are based on above-trend growth of 2.3% in the US, global growth of 2.9%, generally favorable monetary policy and more stimulative fiscal policy across developed and emerging market countries. We expect returns to be muted across asset classes, resulting in modest returns in a diversified portfolio with a modest enhancement from tactical tilts. Of course, our views are not without risks. As we discuss below, some are low-probability risks with the potential for high impact while others are high-probability risks with low impact potential. The Risks to Our Outlook When we think about the risks to our economic and financial market outlook, we are reminded of the words of French writer Jean-Baptiste Alphonse Karr: Plus ¢a change, plus c'est la méme chose—the more things change, the more they stay the same. This year’s list of risks overlaps with those of the last several years. As far back as 2011, investors have worried about a hard landing in China. From the inception of the European sovereign debt crisis in 2010 through the Brexit vote in 2016, the potential breakup of the Eurozone has been a source of concern. As soon as the Federal Reserve raised the federal funds rate in December 2.015, investors worried about tightening policy causing a recession. Cybersecurity and terrorism are constant threats. And geopolitical risks have grown over time. This year, we are adding trade policy uncertainty and US- China geopolitical relations as new risks. As we said in our 2013 Outlook, there is no shortage of concerns as markets climb a wall of worry. In our view, there are eight risks that Outlook | Investment Strategy Group 25 HOUSE_OVERSIGHT_014558