To be sure, there are good reasons to be Exhibit 47: US Equity Price Returns from Each cautious, as we discussed in Section I, The Risks to Valuation Decile Our Outlook. Even worse, investors are exposed to __ In the past, subsequent returns from high valuation levels these dangers at a time when most asset valuations have been muted. are expensive by historical standards, providing 28 AHAUTALIE mS -veNPRaMUSIORA BrieeneHtT % them with a narrow margin of safety to absorb 47% © «© —¢ — #% Observations With Positive Returns (Right) - 100 such adverse developments. This is particularly 2 HW + 90 true in the US, where valuations have been cheaper * ¢ 6 F 80 at least 90% of the time historically.!°° Even in a a 03 a Europe, where valuations are more attractive, that 8 _ a fact is counterbalanced by greater geopolitical risks , a on and deeper structural fault lines. 45 @ . Still, as we highlighted in Section I of this 7 I z Outlook, there are three reasons why remaining 24 i invested in risk assets is still warranted despite j SS what are likely to be uninspiring returns. First, po 2 3 4 8 6 F 8 8 10 we see only a 15% probability of a US recession, sca which has historically been the key driver of . ° Data as of December 31, 2016. losses in risk assets. Indeed, the S&P 500 has Note: Based on 5 valuation metrics for the S&P 500, beginning in September 1945: Price/Trend generated positive annual total returns 86% of ‘Sm mfuaanon yoann anna ua ial the time during economic expansions in the post- expensive to most expensive and divided into 10 valuation buckets ("deciles"), The subsequent WWI period. Second, the comparable returns “nus we suet ean of investment alternatives—such as cash and Source: Investment Strategy Group, Bloomberg, Datastream, Robert Shiller. bonds—are unappealing, particularly in the rising, = interest rate environment that we expect. Third, risk assets can surprise us to the upside, as last year US Equities: Life in the Fast Lane demonstrated. The p