EFTA01449291

Deutsche Bank Markets Research United States Periodical US Equity Insights 3 reasons not to fear a 3%+ 10yr yield 1600 should be good support even if 10yr treasury yields go a little over 3% As discussed last week, we are increasingly tolerant of higher treasury yields given the coincident climb in the euro and oil prices. Treasury yield normalization poses little threat to S&P EPS provided euro and oil prices prove resilient. Our view that the chief risk to EPS from higher yields is via FX and commodity prices is sometimes challenged by investors who see other threats to EPS from higher interest rates, such as interest expense, or threats to the S&P's valuation. This note gives a few reasons to discount these concerns. Interest expense is relatively small and likely overpowered by pension swings Net interest expense at S&P 500 non-financials is likely under S150bn in 2013, which after-tax is roughly $10 of EPS. Essentially all of the $2trn in net debt at non-financials is now long-term debt because cash is more than double short- term debt and companies have been using more long-term debt in their debt mix. Usually 10-15% of long-term debt rolls over each year and much of it is still rolling to lower rates. But, if we assume that 15% of long-term debt rolls to a rate 100bp higher the hit to 2014 S&P EPS would be -$0.25. If we assume that the effective interest rate rises 200bp on all non-financial net debt the hit to S&P EPS is about $3, but if this occurs it would play out over several years. Pension expense at S&P non-financials is likely to fall more than an increase in borrowing costs as long-term yields rise, particularly through 2015. The improved pension funding we expect at 2013 end should provide a -$2 benefit to S&P EPS in 2014. If yields rise another 100bp at 2014 end it would eliminate deficits and provide another -$2 S&P EPS boost in 2015 (not in our estimates). Pension expense declines would likely stop at this point even if yields climbed higher because of likely shifts in pension asset allocations. This would cause some pension drag from lower ROA assumptions, but all considered lower pension expense should offset higher long-term borrowing rates. Financial earnings will likely benefit from higher treasury yields and eventually higher short-term interest rates. Thus, we see little threat to overall S&P EPS. A IS foiwaid PC wouldn't be threatened until 10vr yields were well over 4% Assuming a fair S&P 500 equity risk premium of 4% (historically 3-4%), it would likely require a 10yr treasury yield of -5% or a 10yr TIPS yield over 2% to threaten the fairness of a -'15 forward PE on normalized S&P EPS. However, such an increase in long-term interest rates would significantly amplify US fiscal risk. Thus, it is important that any such climb in yields be slow and over multiple years, while the deficit is further tamed and housing strengthened. Treasury yields now cooeed the dividend yield, but won't grovy like dividends Dividend yields like earnings yields represent real yields. Expected inflation must be added to these observed yields in order to compare them to nominal interest rates. The 10yr TIPS yield provides a comparable real interest rate, which at 0.75% suggests that EPS and DPS yields remain very attractive. The S&P's indicated dividend yield is 2.1% and we expect DPS growth to be -15% next year and at least 6% thereafter. This suggests an offered long-term nominal return on S&P ownership over 8% with the ability of that offered nominal return to adjust for inflation variations over the long term. 23 August 2013 Slr 1 t Slrair ea Ju Wang Strategist S&P bta) Kir; l ..aimwt3 Price 1660 Next 5%. move Uncertain 2013E 2014E 2015E Year-end Target 1675 1850 2000 EPS 5100 $115 $120 Target P/E 15.4x 16.1x 16.7x Current P/E 15.2x 14.4x 13.8x DPS $36 $40 $45 Sane' ONOCIPOSInt Relabel IOC 1,11 I I (W1i dl Dale Good signals from yields. euro 16 Aug 2013 and oil S&P 500 Pensions: End of 31 Jul 2013 cycles? Multi-year path to PE expansion 14 Jun 2013 How do interest rates affect 31 May 2013 stocks? SLUG Data* Cant 05 away Strategy Basket, Bloomberg Tic km Tech's Enduring Eight DBUSTECH Total Shareholder Return DBUSBEID I Stimulator Dividend Dark Horses DBUSDFCF China Cyclists DBUSCNCY Sant Onscht Sent Deutsche Bank Securities Inc. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054104/2013. CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) CONFIDENTIAL DB-SDNY-0 104635 SDNY_GM_00250819 EFTA01449291