3Q: Patience

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MARKET PERSPECTIVES SERIES

3Q: Patience The stubborn global recovery will reward patience in the end.

COMPANY-INFORMED MACRO PERSPECTIVES FROM THE JANUS FIXED INCOME TEAM

3Q 2014

u COMPANY VIEW



Buying growth

u SECTOR VIEW



Some mergers create jobs

u U.S. VIEW



Back in the game

u GLOBAL VIEW

Japan: On the sidelines

2 4 6 8

u ROADMAP TO JANUS

FIXED INCOME POSITIONING



Near-term credit neutral, interest rate neutral to defensive



10

GLOBAL U.S. SECTOR C O M PA N Y

Janus Company-Informed Macro Perspective Fundamental credit research has been at the core of the Janus fixed income process for over 25 years. Not only does in-depth company research anchor our fixed income investment process, it also serves as the foundation for our macroeconomic views. While most macroeconomic forecasts originate from government data, we start at the bottom, aggregating individual company data from our fundamental credit research to arrive at a company-informed macro view at the firm, sector, U.S. and global levels. We believe this approach differentiates us from our peers and other macroeconomic data providers. Each quarter, our fixed income team shares its company-informed outlook on key macroeconomic indicators and how that insight is applied in Janus’ fixed income portfolios.

The opinions expressed are those of the authors as of July 2014 and are subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes.

3Q: Patience The U.S. economy is on the mend after stumbling in the first quarter. Companies are talking about increased economic activity, and confidence is building by the day. While we hoped for a more robust economic recovery from the crisis, the U.S. recovery continues to look like a moderate one – sustainable yes, but hardly exciting. The slower recovery has created a rather challenging market. Over the span of my investing career, there are two elements of investing that have been drilled into my head: Patience and discipline. This market calls for both. Due to the first quarter setback, our forecast for 2014 growth has been lowered to 1.8% from 2.5%, another reminder of the patience it is taking to get to above-potential growth. The bond bears who thought Treasury yields would rise as the recovery gained momentum have been proven wrong yet again. Treasury yields have declined from the start of the year. Credit and mortgage spreads have tightened. One could argue that fundamentals support the decline in yields as the U.S. Federal Reserve and central banks around the globe have kept very supportive monetary policies in response to tepid growth globally. For example, Japan has launched an ambitious plan that combines aggressive monetary and fiscal policies to keep its own recovery afoot. For our opinion on Japan, read our Global View. Meanwhile, low yields have allowed companies to take advantage of cheap financing to make acquisitions. Our Company View examines how companies are struggling to grow organically and are “buying growth.” As long as the credit markets are accommodating, we expect these trends will continue. In the Sector View, we discuss how mergers in the telecommunications and cable sectors are in fact fueling economic growth. These mergers are being driven by network infrastructure upgrades to accommodate the growing hunger for wireless communication and media services. Network build-outs can create jobs. Job creation generally spurs spending, which in turn, fuels the economy. We are closely watching these elements of job creation as well as the job cuts that mergers can entail. In keeping with the mixed economic effect of mergers, economic data itself has been uneven at times. In response, complacency around lower interest rates has been punctuated by periods of anxiety about an eventual rise in rates. U.S. Treasurys have shown some of the highest volatilities when compared to different segments of the market – an outcome that makes us increasingly uncomfortable. Active management is crucial amid the interest rate uncertainty. Clearly, expectations of higher rates have been challenged, and the direction of rates is the greatest point of debate within Janus’ fixed income team. We believe there will be opportunities created in either low or rising interest rate markets. To that end, we will continue to position our portfolios defensively to try to take advantage of market shifts. Enduring loose monetary policy has made many investors complacent about low rates. These investors are willing to stretch for yield and returns by going down in credit quality and extending duration. Consequently, rich valuations in the credit and mortgage markets are carrying greater downside risk. These trends could be in place for some time, at least until monetary tightening occurs. We’re often asked by our clients: What should we do in this environment? Where do we go? We always turn back to our core tenets: Risk-adjusted returns and capital preservation. We still favor credit. To be sure, valuations require our being increasingly selective. Security avoidance could be just as effective as security selection in generating competitive returns while also protecting on the downside. We see significant opportunities into the second half of 2014, including those that buck the consensus – an area where we have expertise through our bottom-up, fundamental approach. It is not a time for complacency. It is a time for patience and discipline. Read on to learn why this environment demands both.

Gibson Smith Chief Investment Officer, Fixed Income Company-Informed Macro Perspectives | 1

T H E C O M PA N Y V I E W

Buying growth c o mp a n y - i n f o r m e d m a c r o

u

Companies are turning to acquisitions amid a struggle to grow organically. u Mergers aim to cut costs and grab market share. u Domicile relocations after mergers are moving capital abroad. Taking growth, not fueling it Mergers are running rampant across corporate sectors this year, and why not: Firms are flush with cash after deleveraging, and financing is cheap. In June alone, we saw proposed mergers between Medtronic and Covidien, Tyson and Hillshire Brands and Level 3 and TW Telecom. While the U.S. economy is recovering after a first quarter stumble, this upturn is in spite of mergers, not because of them. Mergers are usually about cost cutting and grabbing existing market share, not about job growth and creating new markets. This is sending a signal about the macro picture: The recovery has been uneven, and firms are challenged to grow profits and sales organically.

JPMorgan Chase says the environment remains compelling for M&A activity, with announced volumes already up 20% this year.

Men’s Wearhouse is touting planned store growth and product breadth after buying Jos. A. Bank. 2 | 3Q 2014

Indeed, throughout the recovery, firms have been slow to ramp up hiring and capital expenditures. While we saw some improvement on both fronts as we entered 2014, many companies have decided that acquisitions are a greater return on investment. Mergers between Office Depot and OfficeMax in the retail sector and Verso Paper and NewPage in the paper sector aim to cut excess capacity. Meanwhile, pharmaceutical firms, pressed to protect profit margins, have been merging to engineer tax advantages. Endo Health Solutions bought Canada’s Paladin Labs and then moved the company to Ireland for the lower tax rate. Pfizer attempted to buy AstraZeneca to move to the UK partly for the same reason. This erodes the U.S. tax base, which is a long-term negative for the economy. Bottom line: Mergers may be a boon to individual companies, but this doesn’t translate into a boon for the overall economy.

Tyson cited wider margins and a more stable earnings profile as reasons for buying Hillshire Brands.

MORE M&A ACTIVITY ISN’T THE GROWTH WE’RE SEEKING Quarterly M&A Deal Volume Since 2009

$1.4 Mergers have heated up even amid a decline in first quarter GDP.

$1.2

$1.0

In Trillions

$0.8

$0.6

$0.4

$0.2

$0

1Q

2Q

3Q

4Q

1Q

2009

2Q

3Q

2010

4Q

1Q

2Q

3Q

2011

4Q

1Q

2Q

3Q

2012

4Q

1Q

2Q

3Q

2013

4Q

1Q

2Q

2014

Source: Bloomberg. As of 3/31/14.

KEY IMPLICATIONS u Regardless

of merger activity, we expect economic growth to pick up strongly in the second half as headwinds from an abnormally cold winter have abated.

u We

expect heavy merger activity to continue, especially in sectors where economies of scale are ripe for the picking, such as metals and mining.

u Mergers

can be shareholder friendly when they are accretive to earnings, but they’re a yellow flag for corporate bonds because of the balance-sheet resources that mergers use.

Company-Informed Macro Perspectives | 3

THE SECTOR VIEW

Some mergers create jobs c o mp a n y - i n f o r m e d m a c r o

u

A couple of large mergers are sparking job creation within the telecom and cable sectors. u Telecom and cable mergers will result in network expansions, which require additional hiring. u More hiring will boost consumer spending, a big driver of GDP.

Network expansion, economic expansion Not all merger and acquisition activity is a drag on the economy. Cases in point are Comcast’s proposed acquisition of Time Warner Cable this year and the acquisition of Sprint in 2013 by Japan’s SoftBank. That’s good news for U.S. job growth because the mergers will result in network expansions and upgrades. Besides the internal hiring that is required for the upgrades, Comcast and Sprint contract network infrastructure providers like CommScope and American Tower Corp. also must hire more workers to meet the increased demand. Upgrading cable and wireless networks is crucial to feed the rising hunger for more telecom services and products.

American Tower expects robust infrastructure spending by the wireless industry to continue through the next decade.

4 | 3Q 2014

Verizon says upgrading its network and delivering new services is a top priority in 2014.

The approximately $15 billion in capital spending planned by Sprint in 2014 and 2015 has resulted in both AT&T and Verizon increasing spending on their own network upgrades to maintain their competitive advantage. For its part, Comcast will use its merger with Time Warner Cable to upgrade its own network and broaden services beyond its traditional cable business. These mergers are not only creating jobs to build their infrastructure, but their network upgrades will provide new services that will fuel the economy further.

T-Mobile U.S. describes its network investment as “full steam ahead.”

MORE CAPEX, MORE JOB GROWTH Combined 2010-2014 Capex for Sprint, Verizon, T-Mobile U.S. and AT&T $25,000 The big telecom providers are boosting spending on projects that require hiring, and that’s further fuel for the economy.

2010 2011 2012 2013 2014 (projected)

Capital Expenditures (in millions)

$20,000

$15,000

$10,000

$5,000

$0 Verizon

AT&T

T-Mobile U.S.

Sprint

Source: Janus, Bloomberg and company figures. As of 6/30/14.

KEY IMPLICATIONS u Not

all M&A for the economy is negative. Recent and planned mergers in the telecom and cable sectors will be a net positive for economic growth.

u Mergers

such as those within the telecom and cable sectors will help business spending return to pre-recession levels, the last missing piece of the economic growth puzzle.

u Network

upgrades will enable telecom and cable firms to offer additional services, which will also boost consumer spending and aid growth.

Company-Informed Macro Perspectives | 5

THE U.S. VIEW

Back in the game c o mp a n y - i n f o r m e d m a c r o

The economy is rebounding after its first quarter stumble. u Job growth is steady, consumer spending should stay strong. u Inflation has crept up. u

Key themes remain intact U.S. economic growth is back after a slow start to 2014. We are hearing company officials talk about a rebound in activity and this is being borne out in housing, manufacturing and jobs data.

strength. Hotel-chain operators like Starwood Hotels & Resorts to conglomerates like 3M have been able to pass on higher prices to customers. Inflation has now hit the Federal Reserve’s target.

Beazer Homes said it is starting to see encouraging signs in first-time home buying while its rival DR Horton just created a new brand for first-time buyers to meet demand. Auto plant output at the Big Three is humming along as GM and Chrysler report strengthening sales gains and Chrysler ramps up an aggressive product launch.

We’re not yet concerned by inflation. We still see it as price “normalization,” and the Fed remains on track for a late 2015 rate hike. Thus, our key themes remain intact for 2014: A return to growth, higher inflation (though normalizing) and continued accommodative monetary policy. Business spending, which has been a missing part of the puzzle, is perking up. While we had to cut our estimate for 2014 GDP growth to 1.8% because of the first quarter, we see growth in the second half equating to 3%.

The constant bright spot has been consumer spending. We expect job growth to remain steady enough to keep spending strong even though the overall unemployment rate should trend around 6.5%. Not surprisingly, inflation has started to track spending

FedEx says it’s seeing an increase in demand from small and mid-size customers.

6 | 3Q 2014

Kroger noted customers were more confident about spending starting in the spring.

Marriott International is hearing greater confidence about the U.S. economic recovery from its corporate customers.

U.S. MACROSCAN FA C T O R

TREND

OUTLOOK

CONSUMER u

Consumers remain upbeat with Consumer Confidence at the highest level since 2008.

u

Home prices are up 10.8% year over year (YoY), according to the S&P/Case-Shiller 20-City Index.

u

Nonfarm payroll growth is back in the game, up 288K in June. Job growth averaged 194K/month in 2013 and is now averaging 230.8K in the first half of 2014 with the unemployment rate down to 6.1%.

u

Consumers persevered in 2013, showing signs of strength with modest job creation, increased net worth and stable savings. This bodes well for spending in the second half of 2014.

u

We expect continued home price appreciation, which should boost personal net worth and spur construction sector job creation.

u

We believe the unemployment rate will trend around 6.5% as people exit and re-enter the labor force; however, increased job creation creates upside risk to this estimate.

u

Businesses remain cautious, but we believe second half 2014 will offer sufficient clarity and demand to allow them to move forward. M&A activity is a damper on business spending, but rising demand will help bring business spending back to pre-crisis levels.

u

We now expect full-year gross domestic product (GDP) growth to be 1.8% in 2014, but we have the second half at a 3% pace.

u

We expect year-over-year core CPI for 2014 to be around the Fed’s 2% target, compared with 1.7% in 2013.

u

Consumers should benefit from generally tame commodity prices. We are starting to see pockets of pressure, nothing alarming but consistent with the bottom marked and a normalization underway. Wages remain uneven and are not yet outpacing inflation. All of these factors create a net neutral effect on consumer spending.

u

Bye-bye, fiscal headwinds: with a budget deal reached and the government funded through March 15, 2015, we see fiscal headwinds finally fading.

u

While the Fed is tapering QE, we don’t expect a hike in short-term interest rates before mid-2015. The Fed has finally aligned their communication after a few missteps, but it remains dovish leaning. That will cause the market to move ahead of the Fed’s pace.

BUSINESS u

The pace of business capital expenditure is starting to recover (now up 2.6% YoY), but has not been robust as expected due to 1Q weather disruptions and use of M&A to buy growth.

u

The Institute for Supply Management (ISM) manufacturing index held at 55.3 in June, near the high for 2014 at 55.4.

I N F L AT I O N u

Inflation is normalizing after bottoming out in 1Q. The core Consumer Price Index (CPI) rose to 2% YoY while the core personal consumption expenditures (PCE) price index recovered to 1.5% YoY.

u

Commodity prices remain tame. Oil is trending around $104/barrel and gold is around $1,320/ounce.

u

Inflation expectations remain stable at 2.9% via University of Michigan Inflation Expectation.

F I S C A L & M O N E TA R Y P O L I C Y u

Congress passed a budget deal that will keep discretionary spending at $1.012 trillion for fiscal year 2014; it is looking at a similar bill for 2015. The debt ceiling was raised until March 15, 2015.

u

The Federal Reserve (Fed) has tapered its quantitativeeasing (QE) program by $50 billion, reducing its monthly bond purchases to $35 billion.

Source: Janus.

KEY IMPLICATIONS u We’ve

downgraded full-year 2014 GDP growth to 1.8% from 2.5% due to the first quarter’s GDP decline.

u While

inflation has hit the Federal Reserve’s target, we don’t expect rate hikes until the second half of 2015.

u Job

growth should remain steady, but we expect the overall unemployment rate to trend around 6.5% as people enter and exit the workforce.

Company-Informed Macro Perspectives | 7

THE GLOBAL VIEW

Japan: On the sidelines c o mp a n y - i n f o r m e d m a c r o

Japan’s second-half growth in 2014 hinges on long-term confidence in the government’s plan. u Current and planned sales taxes are a serious economic headwind. u Companies express mixed confidence about Japan’s growth prospects. u

Caution ahead While the U.S. recovery is chugging along, we have doubts about the sustainability of Japan’s. Based on our research from U.S. and Japanese firms, the corporate view on Japan’s recovery is too mixed for us to be firm believers in the country’s economic plan. After all, companies are the ones in charge of hiring and wages. For example, leading Japanese retailer Takashimaya says “it’s difficult to be optimistic about future conditions” for the country’s department store industry. United Continental says Japan’s economy continues to be a drag on results. While the country posted robust gross domestic product growth in the first quarter, much of it was pulled forward ahead of an expected sales tax hike in April. The increase is needed to finance Japan’s generous social programs. The tax hike is also a heavy economic burden: After much pre-hike consumption, we expect that Japan’s GDP will contract in the second quarter. The country’s government is optimistic

Uniqlo store operator Fast Retailing, citing its outlook for Japan, cut its 2014 profit forecast.

8 | 3Q 2014

that it will get growth back on track in the second half of the year, however, the details around Japan’s proposed structural reforms have been met with skepticism by the market. Moreover, firms remained concerned about higher consumer taxes, as the last sales tax hike in 1997 helped drive Japan into a recession. Meanwhile, April’s sales tax increase to 8% from 5% may be met with another hike to 10% in 2015. All in all: We take corporate ambivalence about Japan’s prospects as an important signal for investors.

Paper-making giant Weyerhaeuser says it’s hard to tell how higher sales taxes will play out. After Japan’s April sales tax hike, Toyota and Mazda Motor are seeing steep sales declines.

JAPAN HAS HAD DIFFICULTY SUSTAINING A RECOVERY Japan’s GDP 1994–2014 2.0%

Japan’s sales tax in April has precedence in 1997. Back then, it wiped out GDP growth.

1.5%

1.0%

0.5%

0.0%

Japan GDP Index

Following Sales Tax Hike in April 1997 -0.5%

-1.0%

-1.5%

-2.0%

-2.5%

-3.0% 2008 Global Economic Crisis -3.5% 1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

1Q- 2014

Source: Bloomberg. As of 3/31/14.

KEY IMPLICATIONS u Regardless

of Japan’s planned monetary and fiscal measures, a sustainable recovery will require a tremendous amount of support for a prolonged period.

u Japan’s

recovery plan increases investment risk, including escalating government debt.

u The

yen should remain weak versus major currencies until the Japanese economy is further along in the recovery process.

Company-Informed Macro Perspectives | 9

ROADMAP TO JANUS FIXED INCOME POSITIONING

Near-term credit neutral, interest rate neutral to defensive Janus fixed income portfolios are overweight credit (as of 6/30/14), with a neutral-to-defensive stance on interest rate exposure.

Sector Allocation u

We remain constructive on corporate credit in general. While our credit weighting remains fairly similar to last quarter, we continue to trim richly valued positions and have become increasingly selective given the rally in the sector. Our continued overweight relative to the index reflects our view of the relative attractiveness of credit versus interest rate-focused securities, such as Treasurys.

u

We reduced our credit duration and tactically increased our duration in Treasurys toward neutral with the benchmark. These moves enable us to be opportunistically neutral to defensive along the yield curve given the interest rate environment.

u

Among securitized products, we kept our exposure to MBS steady. We believe the shrinking supply of these securities and steady demand will keep spread levels tight. We are biased toward highercoupon securities due to their lower volatility and because the Federal Reserve is tapering its purchases of lower-coupon MBS. In CMBS, exposure declined slightly due to material early debt repayments.

u

We maintain little exposure to bank loans, where we still think valuations are stretched.

PORTFOLIO POSITIONING SUMMARY Overweight Credit

Opportunistic Positioning

Neutral Positioning

• Investment-grade spreads tighten, high-yield spreads remain wide

• Credit spreads wide relative to risk

Typical market conditions:

• Cautious market • Loosening underwriting standards • Leveraged buyout activity resumes

Typical market conditions:

• Fear predominant in market • Tight underwriting standards • Leveraged buyout activity slows

Low Quality

High Quality Unlikely Portfolio Positioning

Defensive Positioning

Typical market conditions: • Credit spreads tight relative to risk • Greed predominant in market • Loose underwriting standards • Increased leveraged buyout activity

Underweight Credit

1 0 | 3Q 2014

u

u

We remain cautious on emerging market debt but have added tactically to our positions in some of the stronger markets. While we think emerging markets will continue to experience considerable volatility, there are some potential opportunities as fundamentals are improving in specific countries.

u

We are concentrated in the front end of the curve on the higher-quality credits, where we are finding good risk-adjusted opportunities that can generate some carry. Our long-end exposure is more selective, reflecting our defensive stance.

u

We believe security avoidance will be just as important as security selection going forward. Amid rising valuations, increased shareholderfriendly activity can quickly create more risk than reward with individual issuers. These are the type of issuers we seek to avoid.

We believe some peripheral European sovereigns are attractive as fundamentals slowly turn and the European Central Bank reiterates its ultraaccommodative stance.

Credit Spreads u

u

Thus far, the pace of shareholder-friendly activity remains unabated in 2014 with more share buybacks, dividend increases and additional M&A. We expect it to remain high, if not accelerate, as economic activity gains momentum in the latter half of the year. Some caution is warranted with credit as both investment-grade and high-yield spreads are relatively tight. Current spread levels express a very bullish view in the credit markets, in spite of the increased shareholder-friendly activity. We believe it’s important not to stretch for yield in this environment.

Duration* u

Duration contribution from U.S. Treasurys, and sovereigns where applicable, remains less than that of the indices, consistent with our concerns around interest rate volatility. We do still maintain certain short-duration Treasury positions for the sake of liquidity.

* Duration measures a bond price’s sensitivity to changes in interest rates. The longer a bond’s duration, the higher its sensitivity to interest rates, all else being equal.

Company-Informed Macro Perspectives | 11

Janus Global Macro Team

12 | 3Q 2014

Lindsay Bernum Global Macro Analyst

Chris Diaz, CFA Head of Global Rates and Portfolio Manager

David Spilsted Emerging Market Analyst

Seth Meyer, CFA Global Credit Analyst and Portfolio Manager

Ryan Myerberg Portfolio Manager and International Fixed Income Trader

Aspen Large Portfolio Risk Analyst

Brad Smith Global Credit Analyst

Michael Keough Global Credit Analyst and Assistant Portfolio Manager

u

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