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Market strategy Market strategy Document Transcript

  • July 9, 2012 Market Strategy Macro & Portfolio Strategy Market Commentary/StrategyStifel 3Q12 Macro: 1,600 S&P 500 in 2012 on 2H GDP Traction & Policy MovesWe see 2H12 U.S. GDP recovery lifting the S&P 500 to 1,600 in 2H12 (P/E ~16x). Late secular bearmarkets move quickly and discourage trend following. The U.S. rebalancing borne of crisis is 3-4years ahead of the eurozone and China, enforcing a U.S. playbook. We believe self-preservationinstincts should soon take hold for overseas political & monetary institutions under rising duress,leading to a eurozone bank liability guarantee (collapsing spreads, ending capital flight) that is a backdoor to fiscal control (i.e., control of sovereign issuance via bank asset oversight), Chinastimulus/acceleration of the 5-year plan (bridging fixed investment vs. consumption, social spending),coordinated central bank monetary ease to offset fiscal austerity (if real), and political calculus thatforces fiscal cliff negotiation into Nov/Dec-12. We like Tech/Growth in a P/E expansion market, butexpect Financials to lead the S&P in 2012, ringing the late cycle bell at the top. S&P 500 as of 07/06/12: $1,354.68In Our ViewU.S. Equity Outlook [See pages 2-14]Rapid S&P lift to 1,600 by year-end, Tech & Financials lead, inevitable policy moves.Fiscal & Monetary Policy [See pages 15-22]Fed/Treasury “create” S&P EPS (hurting EPS quality), but policy outlasts skeptics.EU & China Transition Risk [See pages 23-26]ECB crisis blanket guarantee with supervision; China fiscal stimulus “Hail Mary” pass in 2H12.Housing & Labor Outlook [See pages 27-31]Payrolls to improve 2H12 as productivity cyclically peaked, construction up in 2H12/2013.Paper vs. Hard Assets [See pages 32-41]Policy-driven bounce later in 2012, but commodity economic profit tailwind has ended.Long-term Equity Outlook [See pages 42-47]Choppy 7%-9% equity return (price + dividends) 2012-2022E, too late to be a super-bear.Barry B. Bannister, CFA bbbannister@stifel.com (443) 224-1317Stifel Nicolaus Equity Trading Desk US: (800) 424-8870 Canada: (866) 752-4446Stifel Nicolaus does and seeks to do business with companies covered in its research reports. As a result,investors should be aware that the firm may have a conflict of interest that could affect the objectivity of thisreport. Investors should consider this report as only a single factor in making their investment decision.All relevant disclosures and certifications appear on pages 48 - 49 of this report.
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 U.S. Equity Outlook In our view: • We see 2H12 confidence in reflation (avoidance of deflation) lifting the S&P 500 to 1,600 in 2H12 led by Financials as well as Tech “duration” growth equity(1) at the expense of bond equivalent equities (Utilities, Communications). • The U.S. wrote the playbook for addressing the eurozone crisis, and overcoming their resistance to the U.S. prescription of coordinated fiscal and monetary policy response has been the challenge. • Inflation lowers P/E ratios, and deflation dims EPS, but navigating the extremes of inflation and deflation, which we see in 2H12, as well as loose monetary policy as the offset to fiscal tightening, is the sweet spot for equity we see. • We realize S&P EPS supported by the Treasury and Federal Reserve are of lower quality, but investor confidence that policy will be sustained could lift stocks and lower the Equity Risk premium, which is near 40-year highs. • We believe the top will be evident when Financials (note lending is late cycle in de-leveraging) beat the worst performing sector (probably Utilities, a bond proxy) by the “normal” ~45% gap between the best and worst groups. • If we are wrong in 2H12 it may be due to the Fed being out-gunned by deflation – a liquidity trap, or recession. We see that as a mid-decade, but secular bear markets require that we view the future as a series of short-term trades. • Commodity stocks may bounce on European euro-crisis confidence (stronger euro, weaker dollar) and Chinese stimulus, late 2012 events we expect, but we think commodity-related economic profit has peaked, so we are wary. • There is precedent for weakness overseas, domestic GDP traction, capital flows to the U.S., a surging dollar, U.S. P/E expansion, Europe struggling with currency union and cheaper fuel - it was the equity-friendly “late 1990s.” (1) Duration is a bond concept that applies to equities, measuring the sensitivity of price to a change in interest rates (in the case of equity, inflation/deflation as it affects the earnings yield, which is the inverse P/E ratio). Duration “Growth” stocks are low dividend payout, high unit growing (minimal reliance on pricing power), low asset intensity, high /well-protected margin (network effects, patents/copyrights) companies with above-average return on generally un-levered equity. Page 2
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Recapping our views at the end of each quarter in 2012: Our 1Q12 Outlook click favored the U.S., and targeted S&P 500 1,400 with mid-year deflation concerns. Jan-3, 2012 S&P 500 1,277.06 Our 2Q12 Outlook click harbored mid-2012 growth concerns, and noted the S&P 500 had little upside. Apr-2, 2012 S&P 500 1,419.04 On May 29 click we raised our 2012 S&P 500 view to 1,600 and a spring-loaded market remains our view. May 29, 2012 S&P 500 1,332.42 Page 3
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Some confidence in reflation (i.e., avoidance of deflation) is our 2H12 view, and much like 1Q12 (left table) we see this as a catalyst for Financials as well as Tech “duration(1)” growth equity to rise while bond equivalent equities (Utilities, Communications) lag. Alternatively, deflation produces the opposite outcome, as occurred in 2Q12 (right table), but we see a reversal of that in 3Q12. "Risk On" Reflation Confidence "Risk Off" Deflation Fear 1Q12 Relative Total Return 2Q12 Relative Total Return Relative Relative Total Return Total Return Electronics (Semis, aero/def., computing, telco eq.)…………………………………………………………………….. 10.9% Communications…..…………………………………………………. 15.2% Banks & Financial Services………………………………………………….…………………………………………………. 10.4% Utilities………………..…………………………………………………. 8.6% Consumer Durables……………………………………………………. 7.8% Health Technology………………………………………………….…………………………………………………. 6.8% Technology Services (Software, internet)…………………………………………………………………….. 3.4% Retail Trade…………………………………………………………………….. 5.6% Consumer Services (Media, restaurants, lodging)…………………………………………………………………. 3.1% Consumer Non-Durables…………………………………………………………………. 5.6% Producer Manufacturing…………………………………………………………………….. 2.9% Transportation……………………………………………………………………………. 5.4% Process Industries (Chemical, ag, paper)………………………………………… Consumer Services (Media, restaurants, lodging)…………………………………………………………………. 2.9% 3.2% Health Services………………………..…………………………………………………. 2.6% Health Services………………………..…………………………………………………. -0.5% 3Q12 Retail Trade…………………………………………………………………….. 0.6% Process Industries (Chemical, ag, paper)………………………………………… -0.8% Distribution Services…………………………………………………………………….. -1.8% Distribution Services…………………………………………………………………….. Commercial Svcs (Finl. pub., personnel, advertising)…………………………………………………………………….. -2.4% Energy Minerals……………………..…………………………………………………. -0.9% -1.4% view Health Technology………………………………………………….………………………………………………….pub., personnel, advertising)…………………………………………………………………….. -3.0% Commercial Svcs (Finl. -2.5% Consumer Non-Durables…………………………………………………………………. -5.4% Producer Manufacturing…………………………………………………………………….. -2.9% Transportation……………………………………………………………………………. -5.6% Technology Services (Software, internet)…………………………………………………………………….. -3.3% Non-Energy Minerals…………………………………………………… -7.4% Industrial Services (Oil svc./equip., E&C, pipelines)……….. -5.0% Industrial Services (Oil svc./equip., E&C, pipelines)……………………………….. -7.6% Electronics (Semis, aero/def., computing, telco eq.)…………………………………………………………………….. -5.6% Communications…..…………………………………………………………. -9.1% Non-Energy Minerals…………………………………………………… -5.9% Energy Minerals……………………..…………………………………………………. Banks & Financial Services………………………………………………….…………………………………………………. -9.6% -7.0% Utilities………………..………………………………………………………….. -13.9% Consumer Durables……………………………………………………. -8.6% --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- KEY: CORE GROUPS TRADING GROUPS Core favored groups in "sweet spot" that avoids both the "Value" trade for alternating reflation/deflation sentiment deflation and inflation extremes, i.e. long duration equity Bond equivalents, representing "Deflation" and "Risk-Off" Source: Factset, Stifel annotations. Relative returns are measured against S&P 500, including dividends. (1) Duration is a bond concept that applies to equities, measuring the sensitivity of price to a change in interest rates (in the case of equity, inflation/deflation as it affects the earnings yield, which is the inverse P/E ratio). Duration “Growth” stocks are low dividend payout, high unit growing (minimal reliance on pricing power), low asset intensity, high /well-protected margin (network effects, patents/copyrights) companies with above-average return on generally un-levered equity. Page 4
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 This is the 4th “Secular Bear Market” the past century (left chart), each of which de-capitalized equity as a percentage of GDP from elevated starting points (1907, 1929, 1968, 2000). Within secular bear markets there are rough “stages” of investor psychology (right chart), and we see a “Late Bull” momentum phase and rally to 1,600 (only slightly higher than the 2007 and 2000 peaks). Phases of a Secular Bear Market - The S&P 500 (1,362 as of 06/29/12) Late Bull Early Late Bear Early Nominal S&P 500 (S&P Composite before the existence of the Late Bull Bear Market Bull Mature Bull Bull Market Bull Mature Bull 10,000 S&P 500) - Chart is through June 2012 Momentum Defensive Oversold Multiple Momentum Defensive Oversold Stocks 200dma Stocks crosses Est. 1600 1500 1,000 1400 2000 to Present 1300 Nominal S&P 500 1200 100 1100 1968 to 1982 1000 900 10 800 1907 to 1921 1929 to 1949 700 1 600 06/01/98 12/01/98 06/01/99 12/01/99 06/01/00 12/01/00 06/01/01 12/01/01 06/01/02 12/01/02 06/01/03 12/01/03 06/01/04 12/01/04 06/01/05 12/01/05 06/01/06 12/01/06 06/01/07 12/01/07 06/01/08 12/01/08 06/01/09 12/01/09 06/01/10 12/01/10 06/01/11 12/01/11 06/01/12 1895 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: Stifel Nicolaus estimates, Standard & Poors, Factset prices. Page 5
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 We believe slowing S&P 500 EPS is embedded in economic data (left chart), and the Equity Risk Premium falling from 5.2% to 3.5% achieves our 1,600 S&P 500 in 2012 price target (right chart). S&P 500 forward EPS consensus ~$109 (the A 2012E S&P 500 P/E ~16X (6.25% avg. of 2012-13E) already embeds a sharply Earnings Yield) and 10Y ~2.75% would slowing Durable Goods y/y percent change. narrow the Equity Risk Premium to 3.5%. S&P 500 Operating Earnings (Left Axis) vs. S&P 500 Earnings Yield minus 10-Yr. Risk Free U.S. Government Durable Goods New Orders (Right Axis), 16.0% Bond Yield... Y/Y % Changes, Jan-93 to Present 15.0% 14.0% 50% 40% 13.0% 12.0% Truncated 11.0% 40% at 50% 30% 10.0% earnings 9.0% growth 8.0% 30% 7.0% 20% X 6.0% 5.0% 20% 4.0% 10% 3.0% X 2.0% 10% 1.0% 0% 0.0% 0% 7.0% ...Equals the Equity Risk Premium -10% 6.0% -10% S&P 5.0% Consensus 4.0% Ests. -20% -20% $103.75 12E 3.0% $114.28 13E 2.0% -30% 1.0% -30% 0.0% S&P 500 Operating Earnings -40% -40% -1.0% Durable Goods: New Orders, y/y % 3 -2.0% -50% mo. avg. -50% -3.0% -4.0% Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 -5.0% Jan-62 Jan-64 Jan-66 Jan-68 Jan-70 Jan-72 Jan-74 Jan-76 Jan-78 Jan-80 Jan-82 Jan-84 Jan-86 Jan-88 Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 Source: FactSet Prices, Moody’s Economy.com data, Stifel Nicolaus format Page 6
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Inflation lowers P/E ratios, and deflation dims EPS, but navigating the extremes of inflation and deflation, which we see in 2H12, may be a sweet spot for equity at ~2% CPI inflation. We see ~2% inflation and a P/E ~17x applied to 2012 quality-adjusted EPS view of ~$95, or 1,600 for the S&P. Note this is a P/E of only ~14.7x the (albeit falling) consensus ~$109 avg. EPS in 2012-13E. U.S. Consumer Price Inflation (Inverted, Right Median % of months S&P P/E ratio since Jan-1870 Axis) vs. S&P 500 P/E Ratio (Left Axis), 100 Years at that level in that range of An S&P 500 5-year average P/E of 17x is applicable (Deflation)/ of deflation/ (Deflation)/ 28X to ~2% annual inflation. -7.0% Inflation inflation Inflation 27X -6.0% 26X -5.0% 25X Post-war deflation is (10.0)% + 14.1x 3.5% 24X destructive to EPS, leading -4.0% (9.0)%-(9.9)% 14.0x 1.5% 23X to higher P/E ratios -3.0% 22X (8.0)%-(8.9)% 16.6x 1.1% -2.0% 21X -1.0% (7.0)%-(7.9)% 13.1x 1.3% 20X (6.0)%-(6.9)% 12.8x 1.6% 0.0% 19X (5.0)%-(5.9)% 13.8x 2.6% 18X 1.0% 17X 2.0% (4.0)%-(4.9)% 15.6x 2.2% 16X 3.0% (3.0)%-(3.9)% 14.7x 1.4% 15X 4.0% (2.0)%-(2.9)% 14.8x 2.9% 14X (1.0)%-(1.9)% 14.8x 3.6% 13X 5.0% 12X 6.0% (0.1)%-(0.9)% 12.5x 2.6% 11X 7.0% 0.0% 14.9x 3.6% 10X 8.0% 0.1%-0.9% 12.6x 3.3% 9X W.W. II Cold 9.0% 1.0%-1.9% 17.1x 13.0% Optimal P/E at 8X 7X War 10.0% 2.0%-2.9% 17.2x 13.0% inflation ~2% 6X 11.0% 3.0%-3.9% 15.9x 12.2% 5X 12.0% 4X 4.0%-4.9% 15.1x 6.5% Wartime inflation is destructive to P/E ratios 13.0% 3X 5.0%-5.9% 15.0x 4.3% (but not EPS), leading to lower P/E ratios. 14.0% 2X 6.0%-6.9% 11.3x 4.0% 1X W.W. I 15.0% 7.0%-7.9% 12.0x 2.7% 0X 16.0% 8.0%-8.9% 11.8x 1.7% 1911 1916 1921 1926 1931 1936 1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 9.0%-9.9% 9.2x 2.2% >10.0% 9.0x 9.1% P/E of the S&P 500, 5-Yr. Moving Avg. (Left) 100.0% U.S. CPI Inflation, Y/Y % Chng., 5-Yr. Moving Avg. (Right, INVERTED) Source: Robert J. Shiller data www.econ.yale.edu and Standard & Poor’s price and EPS data. U.S. Census and BLS inflation data. The chart above, left is the period 1911 to 2011 expressed as annual averages, rolling 5 year basis, and the table above, right is the period since January 1870 based on monthly data. Page 7
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 We realize S&P 500 EPS supported by the Treasury (left chart) and Federal Reserve (right chart) are of lower quality, but investor confidence that policy will be sustained could lift stocks, in our view. Weak housing (a part of “Net Investment” below) has Fed commitment to a negative real Fed Funds (Fed been offset by deficits that “prop-up” GDP. Funds minus y/y inflation) has boosted margins(1). Reduced "Investment" spending (i.e., housing) Real Fed Funds Rate (FFR), Advanced 5 Qtrs (Red, led to large deficits to support GDP Right) vs. Corporate Profit Margins (Blue, Left) 14% 23% -4% 1985 - Current 22% 12% We think margins are -3% ~500bps elevated, but 21% 10% margins and S&P returns -2% are not well correlated. 20% 8% -1% INVERTED AXIS 19% 6% 0% 18% % of GDP 4% 17% 1% 2% 16% 2% 0% 15% 3% -2% 14% 4% 13% -4% 5% 12% -6% Corporate Profit Margins (Left) 6% 1Q1947 1Q1951 1Q1955 1Q1959 1Q1963 1Q1967 1Q1971 1Q1975 1Q1979 1Q1983 1Q1987 1Q1991 1Q1995 1Q1999 1Q2003 1Q2007 1Q2011 11% Real Fed Funds Rate (Inverted, Right) 10% 7% 1Q1985 1Q1987 1Q1989 1Q1991 1Q1993 1Q1995 1Q1997 1Q1999 1Q2001 1Q2003 1Q2005 1Q2007 1Q2009 1Q2011 1Q2013 Net Private Investment Net Govt Saving/(Deficits if >0%) Source: BEA, BLS, NIPA Flow of Funds, U.S. Fed. Corporate margin is pretax corporate profits (adj. for IVA & CCA) as % of gross value added by corporations. (1) A negative real FFR boosts export competitiveness, translation gains, margins (if U.S. firms don’t pass through currency gains) and shifting wealth from creditors to debtors. Page 8
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Our Financial stock rally call is really just hurdling low market expectations. Lagging bank stocks and the falling 10Y yield (left chart) have been the same trade – deflation worries. Since lending is “late cycle” in a private sector de-leveraging we believe Financials may bring up the rear for the S&P 500 (right chart). Longer term, we agree that banks face over-capacity, private sector de- leveraging (deflation), over-regulation, lower leveraged returns, derivatives exposure to overseas and tighter spreads due to Fed policy. But that is the long term, and we are just looking at a trade. US Major and Regional Banks Relative to S&P500, Total Return (Black, Left) vs. US Constant Maturity 10-Yr S&P 500 vs. S&P 500 Ex-Financials (Rebased), Treasury Yields (Red, Right), Jan-06 to present Jan-2007 to Present $2,000 100.0 5.40% $1,900 95.0 Banks Relative to $1,800 S&P500 (Left) 4.90% 90.0 U.S. 10-Yr. Treasury $1,700 Yield (Right) 85.0 4.40% $1,600 80.0 QE1 $1,500 QE2 3.90% 75.0 $1,400 $1,300 70.0 3.40% GDP traction $1,200 65.0 + Fed policy 2.90% $1,100 60.0 ~2.75% X $1,000 10Y? 55.0 2.40% $900 50.0 Nov. 25, 2008 Fed Aug. 26,2010 $800 1.90% announces asset Jackson Hole S&P 500 45.0 purchase plans, $700 Fed QE2 hint. doubles up Mar-09. S&P Ex-Financials (Rebased) 40.0 1.40% $600 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 May-07 May-08 May-09 May-10 May-11 May-12 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Source: Bloomberg, Factset data, Stifel Nicolaus format. Page 9
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 We think the S&P 500 “top” at ~1,600 will occur when Financials beat the worst performing sector (probably Utilities, a bond proxy) by the “standard” 40%-50% gap (left chart). S&P 500 profits have shifted from Financials to Technology since the secular bear market began in 2000, accelerated by the 2008-09 crisis (right chart). Our expectation is that Technology-as-growth will be re-rated upward concurrent with Financials bouncing in relief due to the avoidance (for now) of deflation. Annual gap: best minus worst S&P sector % of S&P 500 Income from Continuing prof it Operations by Sector Other than crisis years, the gap is usually ~40%-50% 100% Utilities 150% 140% 90% Telecom. Tech Services 130% 80% larger Materials 120% 110% 70% Info. Tech. 100% 60% 90% Industrials 80% 50% Health Care 70% Finance 60% 40% smaller Financials 50% 30% Energy 40% 30% 20% Consumer 20% Staples 10% 10% Consumer Discretionary 0% 0% 2011 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1Q00 4Q00 3Q01 2Q02 1Q03 4Q03 3Q04 2Q05 1Q06 4Q06 3Q07 2Q08 1Q09 4Q09 3Q10 2Q11 1Q12 Source: Stifel Nicolaus chart, Factset prices. Dip in the right chart is due to Finance sector sustaining large operating losses in the aggregate 2008-09. Page 10
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 If we are wrong about Financials (and duration equity) in 2H12 it is because the Fed is out-gunned by deflation – a liquidity trap, or a recession. Fed rate manipulation since 1982 (10-yr. minus FFR, left chart) between (1)% inversion (slows lending) and +3.5% ease (restarts lending) must bounce closer to +2.75% (i.e., 10Y 2.75% minus FFR 0%) for our call to be correct. If we are wrong, the 10Y minus FRR may fall to ~0.5% (i.e., 10Y drops to 0.5%, FFR 0%). So far, however, lending appears to be above nominal GDP (right charts), lifting leverage. We see this as only a trade, not an end-game, however. Total Loans & Leases at Commercial Banks y/y% Fed rate manipulation (10-Y minus FFR): MINUS Nominal GDP Growth y/y% Between ~(1)% inversion and ~3.5% accommodation 16% i.e, loan growth above/(below) 0% in the chart is 14% above/(below) U.S. nominal output growth 4.0% 12% 10% 8% 3.5% 6% 4% 2% 3.0% 0% -2% X -4% 2.5% (win) -6% -8% -10% 2.0% -12% -14% Dec-48 Dec-50 Dec-52 Dec-54 Dec-56 Dec-58 Dec-60 Dec-62 Dec-64 Dec-66 Dec-68 Dec-70 Dec-72 Dec-74 Dec-76 Dec-78 Dec-80 Dec-82 Dec-84 Dec-86 Dec-88 Dec-90 Dec-92 Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 1.5% 1.0% U.S. Commercial Bank Credit as % of U.S. Nominal GDP Jan-1947 to present 0.5% X 68% (lose) 65% 0.0% 62% 59% Periodic (not 56% linear) deflation -0.5% 53% (de-leveraging) 1970s prolonged 50% shocks inflation helped -1.0% Post-WW II inflation de-leveraging. 47% followed by real 44% growth led to de- -1.5% 41% leveraging. 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 38% 35% 32% Jan-47 Jan-50 Jan-53 Jan-56 Jan-59 Jan-62 Jan-65 Jan-68 Jan-71 Jan-74 Jan-77 Jan-80 Jan-83 Jan-86 Jan-89 Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 10-Year Treasury minus Fed Funds Rate (FFR) Source: FDIC, St. Louis Fed data, Stifel Nicolaus format. (1) We see Commercial & Industrial (19% of loans) ~7% growth, Real Estate (~50% of total) ~2% growth, and Consumer & Other (~31% of total loans) ~5% growth for about ~4% loan growth in the intermediate term. Nominal GDP rebounding to ~5% (3% real, 2% inflation) is our expectation. Actual 6/20/12 y/y Commercial Bank loans were +2.9% y/y in total, led by +17.0% C&I, negative (1.9)% Real Estate (Home Equity + Residential + CRE), and +3.2% Consumer & All Other loans & leases. Page 11
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Are commodity stocks the other value trade? With their economic profits possibly peaked they may be a similar short term trade, in our view. Commodity equities prosper when pricing power Commodity Price Index, Log Scale 100.00 dependent ROIC(1) is high and cost of capital Data 1897 to present (market returns) are low. This “economic profit” gap appears to us to have peaked, possibly pressuring commodity stock valuations for years. 1999-2011 1968-80 When commodities lead, the S&P 500 lags (the 10.00 growth stocks mostly) 10-yr. Growth Rates 13% 1932-51 20% 1907-20 12% 11% 18% 10% 16% 9% 1.00 1897 1902 1907 1912 1917 1922 1927 1932 1937 1942 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 8% 14% 7% 12% 6% 10,000 S&P 500* 5% 10% Data 1897 to present 4% 8% 3% 6% 1,000 2% 2000 to Nominal S&P 500 1% 1968 to 4% Present 1982 0% 2% 100 -1% 1929 to 1907 to 1949 -2% 0% 1921 -3% -2% -4% 10 -5% -4% 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013E *S&P Composite before the existence of the S&P 500. 1 U.S. Commodity Price Growth (%), Left Axis 1897 1902 1907 1912 1917 1922 1927 1932 1937 1942 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 U.S. Large Cap Stock Market Total Return (Price + Dividend), Right Axis Source: Equity total return is Ibbotson or Yale/Standard & Poor’s total return including dividends (left) and price-only (right). Commodities 1897 to 1913 are the WPI for Commodities, 1914-56 the PPI All Commodities, and 1957-present the CRB CCI, now an equal-weighted index of 17 mostly metal, energy and farm commodities. (1) ROIC is Return on Invested Capital. Note also that Cost of Capital is the weighted average after-tax cost risk-adjusted opportunity cost of equity and debt capital. Page 12
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Foreign U.S. equity sales as a contrary indicator(1)? The left chart sums to 100%, depicting foreign purchases of U.S. Equity & Corporate Debt (blue line) vs. longer term Treasuries (red line). Foreigners liquidated U.S. stocks & corporate debt in Jan-91 (Points A), in front of the 1990s stock boom. They next piled into U.S. stocks & corporate debt in Apr-01, a year after the equity Bubble burst (Points B). Now, (Point C) foreigners are again equity sellers, a possible contrary indicator. Net Purchases of U.S. Securities by Foreign Inflation-Adjusted S&P 500 Price Index(2) Official Institutions & Private Investors $2,000 160% (Sums to 100%) $1,900 Bought 140% B Equity $1,800 Bought Equity 120% Apr-01 Selling $1,700 Apr-01 Equity Purchases as a % of Total, LTM 100% $1,600 B Again 80% $1,500 C 60% $1,400 40% $1,300 $1,200 20% $1,100 0% $1,000 Sold -20% Selling Equity Sold Equity C $900 Jan-91 -40% Equity A Jan-91 Again $800 A -60% $700 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 $600 $500 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 U.S. Equities & Corporate Bonds Purchased as % of Total (LTM Totals, Blue Line) Long-Term U.S. Treasuries Purchased as % of Total (LTM Totals, Red Line) Source: U.S. Treasury International Capital (TIC) system (1) There is precedent for weakness overseas, domestic GDP traction, a break-down of economic synchronization, capital flows to the U.S., a surging U.S. $, rising U.S. growth stocks with P/E expansion, Europe struggling to create a currency union and cheaper fuel for U.S. cars - it was the late 1990s, and we are on alert for that possibility. (2) S&P 500 deflated by the CPI-Urban. Page 13
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Planning on waiting for a momentum reversal to buy? That may be too late. Employing “momentum” defined as long “Golden Crosses” and short “Death Crosses(1)” has typically failed to work the last few years of the last three secular bears because market moves occur too rapidly. DJIA: Long Golden Cross/Short Death Cross Nominal Dow Jones Industrials (green) vs. 80% 09/03/1929 to 08/20/1942 100,000 Inflation-adjusted (blue, dash), 1913 to 2012YTD 70% 1929-42 secular bear, 12/10/1934-05/26/1937 11/14/1929-09/28/1932 60% 50% momentum fails after 1938 Secular bear market = range-bound, flat periods in nominal 05/09/1933-05/28/1934 05/26/1937-09/08/1937 09/10/1937-07/25/1938 11/21/1941-08/20/1942 40% terms in which real price levels are under pressure 30% 20% 10% 2000- 0% 09/28/1932-03/02/1933 05/28/1934-12/10/1934 09/08/1937-09/10/1937 07/25/1938-04/04/1939 04/04/1939-09/14/1939 09/14/1939-05/14/1940 05/14/1940-12/03/1940 12/03/1940-02/26/1941 02/26/1941-08/12/1941 08/12/1941-11/21/1941 03/02/1933-05/09/1933 -10% -20% 10,000 -30% -40% -50% -60% DJIA: Long Golden Cross/Short Death Cross 30% 04/28/1966 to 09/13/1982 25% 1966-82 1966-82 secular bear, 03/12/1975-10/18/1976 16 years 20% momentum fails after 1978 10/02/1970-09/14/1971 1,000 15% 04/29/1966-02/27/1967 02/27/1967-12/13/1967 05/28/1968-04/02/1969 06/18/1969-10/02/1970 02/07/1972-04/03/1973 12/06/1973-03/12/1975 10/18/1976-06/02/1978 06/27/1980-08/10/1981 08/10/1981-09/13/1982 10% 1929-42 5% 13 years 0% 12/13/1967-05/28/1968 04/02/1969-05/19/1969 05/19/1969-06/18/1969 09/14/1971-02/07/1972 04/03/1973-11/01/1973 11/01/1973-12/06/1973 06/02/1978-12/08/1978 12/08/1978-04/18/1979 04/18/1979-11/15/1979 11/15/1979-02/04/1980 02/04/1980-03/31/1980 03/31/1980-06/27/1980 -5% -10% -15% 100 S&P 500: Long Golden Cross/Short Death Cross 10/30/00 to present 40% 12/21/07-06/23/09 35% 2000 to present secular bear, 10/30/00-05/14/03 30% 25% momentum fails after 2010 20% 15% 05/14/03-08/18/04 11/05/04-07/19/06 09/12/06-12/21/07 06/23/09-07/02/10 01/31/12-05/25/12 10% 5% 10 0% 1913 1918 1923 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 08/18/04-11/05/04 07/19/06-09/12/06 10/22/10-08/11/11 08/11/11-01/31/12 07/02/10-10/22/10 -5% -10% -15% Source: Factset, Stifel annotations, Dow Jones & Co., BLS inflation. (1) The Golden/Death Cross occurs when the 50 day moving average (dma) crosses the 200dma up/down, respectively. Our point is that the stock market moves more quickly toward the end of secular bear markets because most investors have “caught on” to the trading range strategy. We believe successful investors must pre-position. Page 14
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Fiscal & Monetary Policy In our view: • A sudden 2013 tax hike or oil shock may tip the U.S. into recession, in our view. We think the White House sees an advantage in waiting until Nov-12 (i.e., victory) for the fiscal negotiations, creating possible year-end market volatility. • We observe that there appears to be a tax conflict between the “Establishment” and the “Radicals” that adds an element of ideological risk to budget negotiations that could lead to a fiscal cliff 1/1/2013, a risk we monitor. • U.S. fiscal isn’t a problem until 2015-20, when we see it as the problem. But Federal leveraging concurrent with private de-leveraging is a Keynesian solution made possible only by reserve currency status. • Late decade we expect Federal interest expense as a percentage of GDP to double to ~4% from less than 2% currently, resurrecting at that time the “Bond Market Vigilantes” to enforce fiscal discipline. • For now, our Fed QE indicators are flashing 2H12 easing, and we see a coordinated global Central bank response to fiscal austerity (if real austerity). Rate suppression is a tax on savers that may just work if not done for too long. Page 15
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 A sudden 2013 tax hike or oil shock may tip the U.S. into recession, in our view. U.S. consumer spending on essentials (as a % of income) plunged after the Cold War ended in 1992 (left chart), a typical post-war deflation. But starting in 2001, taxes were cut and interest rates were held low to inflate housing, perhaps a futile attempt to hold back deflation. Energy, health care and food costs trended higher nonetheless, but remain below recession levels. The key now is taxes. Consumer Spending on Essentials, % of Personal Income Consumer Spending on Essentials, % of Personal Red dots mark the start of past recessions Income, by item 46.0% 16.0% 45.6% 45.5% 45.2% 14.0% 45.0% 46% recession 44.7% Healthcare: start average. Out of Pocket 44.5% 44.4% 12.0% 43.6% 44.0% 1Q12 Personal Taxes Paid 43.5% 10.0% 43.3% Mortgage Payments 43.0% (Principal + 8.0% Interest) 42.5% Food Consumed at Home 42.0% 6.0% Energy: 41.5% Personal Transport & 4.0% Utility 41.0% 40.5% 2.0% 1Q1982 1Q1997 3Q2009 1Q2012 1Q1977 3Q1979 3Q1984 1Q1987 3Q1989 1Q1992 3Q1994 3Q1999 1Q2002 3Q2004 1Q2007 1Q1982 2Q1983 3Q1984 2Q1993 3Q1994 4Q1995 4Q2005 1Q2007 1Q1977 2Q1978 3Q1979 4Q1980 4Q1985 1Q1987 2Q1988 3Q1989 4Q1990 1Q1992 1Q1997 2Q1998 3Q1999 4Q2000 1Q2002 2Q2003 3Q2004 2Q2008 3Q2009 4Q2010 1Q2012 Source: National Income and Product Accounts, U.S. Bureau of Economic Analysis, Freelunch, Federal Reserve data including the Financial Obligations Ratio (Homeownership – Mortgage) after 1980 and estimated from 1Q1977-4Q1979 using regression analysis of federal interest data. Page 16
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 We think the White House sees an advantage in waiting until Nov-12 for the fiscal negotiations. The S&P 500 typically bottoms in June during election cycles, especially when the incumbent wins, which we expect due to U.S. 2H12 GDP acceleration. With four more years in office vs. House Republicans facing mid-terms after a recession and deep Defense cuts in their districts, the risk of year-end budget volatility is high, but we expect a begrudging compromise at year end. Chart has been modified. Dow Industrials -- Election-Year Cycle (Incumbent Party Wins vs. Loses) All Elections ( ) We observe that within 111 Incumbent Party Wins ( ) 111 Incumbent Party Loses ( ) the fiscal discourse Incumbent wins if today there appears to 110 economy is 110 be a conflict between stronger. 109 109 the “Establishment” and the “Radicals.” In 108 108 the 1960s and early 1970s the 107 107 Establishment was Plotted Lines Are Average Cycle Patterns 106 106 Conservative and the Based on Daily Data From 1900 Through 2008 For Statistics On Election Year Returns, See Study T_10A Radicals bent on 105 105 revolution were the young Liberals. Now, 104 104 the Establishment is 103 103 Liberal, in our view, and the Radicals bent 102 102 on revolution are the older Conservatives. 101 101 To us that adds an 100 100 element of ideological risk to budget 99 Incumbent 99 negotiations (“You say loses, probably you want a revolution, 98 because 98 well you know…”) that 97 economy is 97 could lead to a fiscal weaker. cliff 1/1/2013 that 96 96 defies all logic, a risk we monitor. 95 95 94 All indices equal-weighted and geometric. S&P Low 94 JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC (DAVIS520) 2012  Copyright 2012 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html . For data vendor disclaimers refer to www.ndr.com/vendorinfo/ . Used with permission/subscriber. Page 17
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 U.S. fiscal isn’t a problem until 2015-20, when we see it as the problem. Federal leveraging concurrent with private Late decade we expect Federal interest to de-leveraging is a Keynesian(1) solution made double to ~4% of GDP, resurrecting the “Bond possible only by reserve currency status(2). Market Vigilantes” to enforce fiscal discipline(3). Debt as a Percentage of U.S. GDP: Avg. Maturity of Federal Debt Outstanding (Months, Left) Federal Debt Held by the Public vs. Household Versus Interest on Federal Debt* as a Percent of GDP (Right) 130% 1945 to 1Q12 Actual, 75 mos. 5.0% with 2Q12 to 4Q21 Ests. The prior era of 120% The next era of 70 mos. Bond Market Change in debt since 2Q08 as a % of GDP (bps) Bond Market 4.5% Vigilantes, 110% Household 2Q08 to 1Q12 change: -1,207 bps Vigilantes Federal Public 2Q08 to 1Q12 change: +3,281 bps 1985-1992 65 mos. 100% 4.0% 90% 60 mos. 3.5% 80% 55 mos. 3.0% 70% 50 mos. 60% 2.5% 45 mos. 50% 2.0% 40% 40 mos. 30% 35 mos. 1.5% 20% 30 mos. 1.0% 1970Q1 1972Q1 1974Q1 1976Q1 1980Q1 1982Q1 1984Q1 1986Q1 1988Q1 1990Q1 1992Q1 1994Q1 1996Q1 1998Q1 2000Q1 2002Q1 2004Q1 2006Q1 2008Q1 2012Q1 2014Q1 2016Q1 2018Q1 2020Q1 1978Q1 2010Q1 10% Federal Debt (Held by the Public) Household Debt 0% 1945Q1 1948Q1 1951Q1 1954Q1 1957Q1 1960Q1 1963Q1 1966Q1 1969Q1 1972Q1 1975Q1 1978Q1 1981Q1 1984Q1 1987Q1 1990Q1 1993Q1 1996Q1 1999Q1 2002Q1 2005Q1 2008Q1 2011Q1 2014Q1 2017Q1 2020Q1 Avg. Maturity of Total Marketable Federal Debt Outstanding (Lef t Axis) Federal Govt Interest Payments % of GDP (Right axis) * Interest forecast assumes the average rate of interest is 4.5% on Federal debt of $24.5B in 2021 with a 5-7 year maturity. Source: Fed, BEA. (1) We see a de facto public for private debt swap that back-fills domestic demand leading to marketable federal debt/GDP that peaks >100% of GDP by the early 2020s. This is a choice available solely to the reserve currency country that can borrow large amounts at an interest rate below nominal GDP growth, in our view. (2) Reserve currency status enables a positive spread between government interest rates and nominal output growth. (3) According to the Social Security and Medicare Boards of Trustees, the Medicare Trust Fund will be exhausted in 2024, Social Security in 2033 and Disability in 2016. Page 18
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Tax revenue (blue line) is mean-reverting and bottoming, while spending (green line) is counter- cyclical and peaking, so we expect the Federal deficit % GDP (red bars) to fall from (6.5)% of GDP in 1Q12 to (4.0)% by 2014, a level that would still be near the post-1971 decade highs for deficits (also red bars), potentially provoking Bond Vigilantes by late decade, in our view. Quarterly Data 3/31/1947 - 3/31/2012 Taxes and Government Spending Note: In the book “This Government Spending as a % of GDP Time Is Different, Eight 25 (65.25-Year Average = 19.7% of GDP) 25 Centuries of Financial 24 3/31/2012 = 24.0% ( ) 24 Folly” by Carmen M. 23 23 Reinhart & Kenneth S. Rogoff, the authors 22 22 X 22% found that Advanced Economy real central 21 21 2014 government revenue 20 20 growth recovers sharply 19 19 the third year [e.g., 2011 in the current period] 18 18 X 18% following major banking 17 17 2014 crises per Figure (10.8) of the book. U.S. tax 16 16 revenue began to 15 Taxes as a % of GDP 15 recover on schedule as (65.25-Year Average = 18.0% of GDP) 3/31/2012 = 17.5% ( ) spending decelerated in 14 14 fiscal 2011. This is 13 Data Subject To Revisions By 13 timely since real public Source: All data fromDepartm of Com erce ent m The Federal Reserve Board debt rises an average 5 3/31/2012 = -6.5% 5 86% in the three years 4 4 3 3 after a financial crisis 2 2 per Figure (10.10) of the 1 Surplus as a % of GDP 1 0 0 book, which closely -1 -1 matches the publicly -2 -2 -3 -3 held U.S. Federal debt -4 Deficit as a % of GDP -4 X 4% increase of +82.6% the -5 4% 4% 4% -5 three years 1Q08 -6 4% -6 2014 -7 -7 through 1Q11. -8 (65.25-Year Average = -1.6% of GDP) -8 (i.e., Not -9 -9 enough) (E300) 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010  Copyright 2012 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html . For data vendor disclaimers refer to www.ndr.com/vendorinfo/ . Page 19
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Our Fed QE indicators are flashing 2H12 easing, which we expect global Central banks to continue in a coordinated fashion in response to fiscal austerity (if fiscal is truly implemented). Gold relative to Brent oil ~16-17x is deflation 30Y Treasury yield TIPS break-even, which (i.e., gold as money(1) is buying more oil), is less manipulated by the Fed, supports which historically triggers a Fed response. Fed responses at a level of ~2%. Gold vs. Brent Ratio (Red, Right) Inflation Expecations: TIPS Breakeven Rates vs. S&P 500 (Green, Left) 3.00% Shaded Areas are QE1/2 & Operation Twist QE1 QE2 TWIST $1,600 26x QE1 QE2 TWIST 25x 2.75% $1,500 24x 23x 2.50% $1,400 22x 21x 2.25% $1,300 20x 19x 2.00% QE2 - $1,200 18x Jackon Hole 17x 1.75% $1,100 16x 15x 1.50% $1,000 14x 13x 1.25% $900 12x 11x $800 10x 1.00% 9x 30YR TIPS Breakeven (LS) $700 8x 0.75% S&P 500 Gold/Brent 7x $600 6x 0.50% 11/1/08 11/1/09 11/1/10 11/1/11 8/1/08 2/1/09 5/1/09 8/1/09 2/1/10 5/1/10 8/1/10 2/1/11 5/1/11 8/1/11 2/1/12 5/1/12 8/1/12 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Source: Factset prices, Stifel Nicolaus format. We call this the “Schrader Rule,” in honor of the Stifel Trader who noticed the relationship. (1) “Gold is money, everything else is credit” is attributed to J. Pierpont Morgan. Page 20
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Ground zero of the crisis was houses, i.e., the culmination (and democratization) of asset inflation(1), but rate suppression is a de facto tax on creditors that may just work... Rate suppression in response to deflation has reduced interest income by ~$500B since 2008 (left chart). But all of the home mortgages written since 2000 total “only” $2.6 trillion (right chart), and rate suppression is a de facto tax on the liquid asset rich that accrues to debtors, eventually cycling back to the asset rich as equity is the residual beneficiary of deleveraging. A progressive tax? Home Mortgage Debt % of U.S. GDP Personal Interest Income shown Still $2.6 Trillion Higher than 1Q2000 as a % of Total Personal Income (Left) As % GDP 1Q2009 80% 75.7% 12.0% and dollar amount (Right) $1.5T of GDP 75% 11.5% 3Q08 70% 1Q2012 $1.4T 63.1% 11.0% 65% of GDP 10.5% 60% $1.3T 55% 1Q2000 10.0% 46.4% of GDP ~$500B 50% 9.5% per year $1.2T 45% 9.0% 40% $1.1T 35% 8.5% 63.1% of GDP now 30% - 46.4% of GDP in 1Q00 8.0% = 16.7% of GDP new debt $1.0T 25% 7.5% 20% x $15.5 trillion GDP 1Q12 = $2.6 trillion added debt 7.0% $0.9T 15% 3/1/2006 9/1/2006 3/1/2007 9/1/2007 3/1/2008 9/1/2008 3/1/2009 9/1/2009 3/1/2010 9/1/2010 3/1/2011 9/1/2011 3/1/2012 9/1/2012 10% 1952Q1 1955Q1 1958Q1 1961Q1 1964Q1 1967Q1 1970Q1 1973Q1 1976Q1 1979Q1 1982Q1 1985Q1 1988Q1 1991Q1 1994Q1 1997Q1 2000Q1 2003Q1 2006Q1 2009Q1 2012Q1 2015Q1 2018Q1 2021Q1 Source: U.S. Federal Reserve, Census, Stifel Nicolaus interpretation and annotations. (1) Leveraged asset excess returns, defined as price change in excess of nominal GDP, progressed from bonds in the 1980s (owned by few) to stocks in the 1990s (owned by the mass affluent) and finally to houses in the 2000s (owned by most). By the time an asset bubble, much like a Ponzi Scheme, reaches the lowest rung and least financially secure investor, it is usually over. This is especially true if the scheme has grown in size (facilitated by Wall Street) to accommodate the bubbles. Page 21
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 We see U.S. real GDP growth of 3% +/- 0.5% per year through 2015, with productivity up to two- thirds of yearly GDP. Low nominal GDP (borderline deflation) is the risk we see, not inflation. Demographically enhanced productivity (which holds back job creation) plus labor force growth equals real GDP of ~3%/yr. to 2015E, and with inflation of ~1-3% that is nominal GDP of 4% to 6%. U.S. productivity over average peak-to-peak business cycles U.S. real GDP y/y percent change (line) is about equal to labor force (6 years) appears to track the ratio of the middle aged to growth + productivity, or 3% +/- 0.5% real growth 2012-15E young workers, supporting 1.5%-2.0% to ~2020, in our view Stifel Nicolaus estimates 2012 to 2015E 8.0% 1.20x 4.00% 7.5% 7.0% 3.75% 1.15x 6.5% 3.50% 6.0% 1.10x 5.5% 3.25% 5.0% U.S. ratio 35-49 to 20-34 year olds, 6-yr. avg. 1.05x 3.00% 4.5% 2.75% 4.0% Productivity y/y%, 6-yr. avg. 1.00x 3.5% 2.50% 0.95x 3.0% 2.25% 2.5% 0.90x 2.00% 2.0% 1.5% 1.75% 0.85x 1.0% 1.50% 0.5% 0.80x 0.0% 1.25% -0.5% 0.75x 1.00% -1.0% 0.75% -1.5% 0.70x -2.0% 0.50% -2.5% U.S. Non-Farm output per hour YY% 0.65x 0.25% -3.0% 0.60x 0.00% -3.5% Size of the U.S. non-farm labor force Y/Y% Mar-11 -4.0% Mar-54 Mar-57 Mar-60 Mar-63 Mar-66 Mar-69 Mar-72 Mar-75 Mar-78 Mar-81 Mar-84 Mar-87 Mar-90 Mar-93 Mar-96 Mar-99 Mar-02 Mar-05 Mar-08 Mar-14 Mar-17 Mar-20 Mar-23 Mar-26 Mar-29 Mar-32 Mar-35 -4.5% U.S. Real GDP Y/Y% -5.0% 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E Nonfarm Business Output Per Hour y/y % Change 3-Year Moving Avg. (Right axis) U.S. Ratio of Workers Age 35-49 To Less Experienced Age 20-34, 6-yr. moving avg. (Left Axis) Source: Stifel Nicolaus estimates, U.S. Census, Moody’s Economy.com inflation, GDP and productivity data. NBER average peak-to-peak business cycle since W.W. II is ~6 years, so that is our period to average demography and productivity. Page 22
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 EU & China Transition Risk In our view: • We think it is in Germany’s best interest (as an over-extended lender) for the periphery to run out of euros (quasi- bank run), so that the periphery must turn to Germany for liquidity on Brussels’ supervisory terms. • Still, Germany’s unrealistic quest for rapid peripheral deflation probably segues to the unit labor cost gap converging over several years, with peripherals that embrace reform seeing the greatest reward (and recovery). • A hurdle is that Germany, with its history of poor financial market relations, does not realize that backstop guarantees can neutralize a crisis at little total cost to the guarantor by collapsing spreads and ending the bank run. • We see banking union as a back door to fiscal union, since the guarantor of bank liabilities (deposits) can negotiate control of the asset side of the bank (peripheral bonds), thus controlling issuance in an indirect but effective manner. • China faces a difficult transition from highly cyclical fixed investment to less cyclical consumption, and prolonged closure of the capital account that risks inflation. China’s worker wave has crested, so now consumption is needed. • To ease the transition to consumption Chinese GDP must preserve the GDP share of fixed investment for now. This may lead to a Chinese fiscal infrastructure plan in late 2012 that boosts commodity equities, in our view. • A rising U.S. share of world GDP as overseas economies painfully rebalance may lift the dollar in a pro-cyclical way (dollar rising for reasons other than flight to safety), which typically lifts “growth” stocks and Financials. Page 23
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 We think it is in Germany’s interest (as an over-extended lender) for the periphery to run out of euros (quasi-bank run), so they must then turn to Germany for liquidity on Brussels’ terms. Germany wants peripheral deflation, but we German central bank credit(2) extended to see unit labor costs(1) converging in both peripheral Europe makes Germany both an over- directions over several years (not quickly). extended lender and the source of liquidity. Unit Labor Costs in Europe: Net Claims on other National Central Banks (NCB) via A gap we see closing by inflating the best ECB/TARGET2, May-2012 (2) (leaving the U.S. well positioned) and deflating the rest Germany is in too deep to trigger insolvencies in the PIGS 1Q2000 = 100, Seasonally Adj. 150 Ireland 699 U.S. and Germany are in-line, but 136 140 periphery + France Germany are un-competitive. Greece 120 Italy Netherlands 130 France 59 Luxembourg Portugal Spain -63 Finland 120 Portugal -98 U.S. Greece 110 -100 Germany Ireland -191 Italy 100 -319 Spain €100 €200 €300 €400 €500 €600 €700 €800 €0 -€400 -€300 -€200 -€100 90 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Euro, Billions Source: World Bank, OECD, People’s Bank of China, China Bureau of Statistics (1) Productivity is output per hour. Unit labor costs are hourly labor costs divided by productivity, or the labor cost per unit of production. (2) Under TARGET2 (Trans-European Automated Real-time Gross Settlement Express Transfer System) the German Bundesbank has lent €699 billion to PIIGS central banks to offset their loss of access to external credit and as a result of bank runs in the periphery (deposit transfers to Germany). Page 24
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 China faces a difficult transition from highly cyclical fixed investment to less cyclical consumption, and prolonged closure of the capital account(1) that risks inflation. China’s worker wave has crested, so now To ease the transition to consumption consumption is needed. China devalued to Chinese GDP must preserve cyclical fixed accommodate a surge in the working age investment. This may lead to a Chinese fiscal population, but that issue crested in 2011. infrastructure plan in late 2012, in our view. Chinas working age population China: Household Consumption (15-64), % of total (LS) vs. Gross Capital Formation, vs. China Yuan per USD (RS) 54% as % GDP, 1980 to 2011 74% 5.00 52% 73% 5.50 50% 72% 6.00 48% ? 71% RMB/$ down, 6.50 46% Will fixed offset by 70% investment Chinese 44% plunge before inflation that 7.00 consumption 69% increases the 42% can pick up real effective 7.50 the slack? exchange 68% rate. 40% 8.00 67% 38% 66% 8.50 36% 65% 9.00 34% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011E 2013E 2015E 2017E 2019E 2021E 2023E 2025E 32% 30% Working Age Population (15-64) % of total 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 China Yuan per USD Source: U.S. Census Bureau International Database forecasts, China Bureau of Statistics, FactSet. (1) GDP = Consumption “C” + Investment “I” + Government “G” + Net Exports “Nx” yet “C” consumption is bottom-up, and can’t be directed top-down the way I, G and Nx may be molded by top-down political authority. In that way, China must relinquish political control of the Capital Account (free the banks) to rebalance toward Consumption, but the nuance is that no top-down country in history has ever had a broad, deep sovereign bond market, and state-sponsored fixed investment China means control of the banks for lending purposes. As a result, we think China is caught in a “Catch 22.” Page 25
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Key to higher U.S. P/E ratios is slowing China and pro-cyclical(1) U.S. dollar strength. China’s reserves and the U.S.$ may again A rising U.S. share of world GDP as the EM converge. China facilitated U.S. credit (and and EU rebalance may lift the dollar. Periods thus dollar weakness) after China’s 2001 of U.S. dollar strength typically lift “growth” WTO entry, but we see that gap closing. stocks and Financials (A, B & C below). Nominal Trade-Weighted U.S.$ Major Currency Index, Historical US Dollar Major Currencies Index 1936 to 2011 (Left) versus U.S. GDP as a share of global vs. Chinese FOREX Reserves GDP in Current U.S. $, 1950 to 2011E (Right) $3,400 Jan-1990 to Jun-2012 $120 120 45% $3,200 $115 110 40% $3,000 Chinese Foreign Exchange Reserves (Billions USD) $2,800 $110 A B US Dollar: Major Currencies Index, Nominal 100 35% $2,600 $105 Nominal trade-weighted U.S. $ C U.S. GDP share of global GDP $2,400 90 30% $100 $2,200 $2,000 $95 80 25% $1,800 $90 $1,600 70 20% $1,400 $85 $1,200 60 15% $80 $1,000 Chinese FX Reserves (Left Axis) U.S. share of $75 50 world GDP and 10% $800 US Dollar: Major Currencies U.S. dollar Index, Nominal (Right Axis) leveling or $600 $70 40 bouncing in 5% $400 2012+, in our $65 view. $200 30 0% 2011 1936 1941 1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 $0 $60 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2013 2011 Source: China Bureau of Statistics, World Bank, IMF, U.S. Fed, pre-1971 FX rates based on trade balances and applicable cross-currency rates. Stifel Nicolaus format. (1) A pro-cyclical dollar rises on higher U.S. relative growth, whereas a counter-cyclical dollar is associated with the risk-off “flight to safety” since about the year 2000. Page 26
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Housing & Labor Outlook In our view: • Peaking cyclical productivity, with hours worked having recovered, means that business must hire to grow at even a modest pace. We see U.S. employment recovering in 2H12. • Returning homeowner’s real “cost of carry” (30Y mortgage rate minus house price y/y%) to its 4% average versus 5.8% currently is how we define housing “recovery.” • We see a slow housing recovery to mid-decade, with 4% (rate suppressed) mortgages and 0% house appreciation. Longer term we see ~2% annual price increases for homes and 6% mortgage rates (6% minus 2% = 4%). • We believe construction (including non-residential) and productivity factors mentioned lift payrolls above the 2007 high of 137.6mm by 2014, dropping the unemployment rate closer to the post-W.W. II average of 5.7%. Page 27
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Peaking cyclical productivity, with hours worked having recovered, means that business must hire to grow at even a modest pace. U.S. output per hour has recovered (left chart), and hours worked has fully recovered (middle chart), so we think business must hire to grow (right chart). Four years before/five years after average(1) business cycle troughs (current = Jun-09) Nonfarm Business: Output per Hour Nonfarm Business: Avg. Hours Private Nonfarm Payrolls, Thsd S.A. of All Persons, S.A. Worked of All Persons, S.A. Troughs = T + 0 Troughs = T + 0 Troughs = T + 0 6.5% 4.0% 4.0% 6.0% 3.0% 3.0% 5.5% 2.0% 5.0% …and hours 2.0% 4.5% 1.0% worked …so business recovered… must hire to 4.0% 1.0% Productivity 0.0% grow, even if cyclically growth is slow. 3.5% peaked for this -1.0% 0.0% 3.0% cycle… -2.0% 2.5% -1.0% -3.0% 2.0% -2.0% 1.5% -4.0% 1.0% -5.0% -3.0% 0.5% -6.0% 0.0% -4.0% -7.0% -0.5% Average Average -5.0% Average -1.0% -8.0% Jun-04 to Current Jun-04 to Current Jun-04 to Current -1.5% -9.0% -6.0% T - 48 T - 36 T - 24 T - 12 T + 12 T + 24 T + 36 T + 48 T + 60 T+0 T + 12 T + 24 T + 36 T + 48 T + 60 T+0 T - 48 T - 36 T - 24 T - 12 T + 12 T + 24 T + 36 T + 48 T + 60 T+0 T - 48 T - 36 T - 24 T - 12 Source: U.S. Bureau of Labor Statistics (BLS), National Bureau of Economic Research (NBER), Stifel Nicolaus format. (1) Includes past seven NBER-declared business cycle troughs; in particular: Feb-61, Nov-70, Mar-75, Jul-80, Nov-82, Mar-91 & Nov-01. Page 28
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Returning homeowner’s real “cost of carry” (30Y mortgage rate minus house price y/y%) to its 4% average (left chart) is how we define housing “recovery.” That may eventually require ~2% annual price increases for homes and 6% mortgage rates (6% minus 2% = 4%). Since we do not expect 2% home appreciation or the ~5% 10Y yields required to produce ~6% yields on 30Y mortgages anytime soon, we see a slow housing recovery to mid-decade, with 4% (rate suppressed) mortgages and 0% house appreciation to occur within the next year or two. The homeowners real cost of carry: 30-year mortgage rates minus appreciation (or Home Price Indices vs. Inflation Trend depreciation) of U.S. national home prices index 250 (4.1% = long-term average) 30.0% 100. 0% 90. 0% Decline to date of 21% for FHFA, 34% for CS- 25.0% Natl, and 37% for CoreLogic indices 200 80. 0% 20.0% Likely flat/slightly 70. 0% 15.0% down for several years, in our view. 4.1% 1988- 60. 0% 150 10.0% 2011 avg. 50. 0% 5.8% 5.0% 1Q12 40. 0% 0.0% 100 30. 0% -5.0% 20. 0% -10.0% 10. 0% 50 Jan-88 Jan-90 Jan-94 Jan-96 Jan-98 Jan-02 Jan-04 Jan-06 Jan-10 Jan-12 Jan-92 Jan-00 Jan-08 -15.0% 0. 0% 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 CS-10 CoreLogic FHFA CPI Trend CS-Natl Shaded areas indicate NBER U.S. recessions. Source: S&P/Shiller price index (left), FHLMC Fixed Rate & National Home Price Indices (right). Page 29
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Non-residential may offer post-bubble lessons for Residential, and lift employment. Post- bubble Non-residential only bounced to its long-term mean before sinking after the 1980s boom/bust (S&L failures, RTC). Residential (right chart) recovery, even if similarly strong off the low, may fade as quickly, in our view, but could for a time improve the jobs picture. Real Non-Res. Construction per Capita Real Residential Construction per Capita $3,000 ($ 2005/capita) $2,300 ($ 2005/capita) $2,900 $2,200 Mortgage- S&L failures, Resolution …and that non-residential adds a backed $2,800 $2,100 Trust Company, “Bad combined $500 per capita faster failures, $2,700 Bank” structures. $2,000 than post-bubble residential can do. FNM/FRE takeover. $2,600 $1,900 $2,500 Short- $1,800 lived $2,400 post- $1,700 bubble $2,300 bounces $1,600 Bubble Bubble $2,200 $1,500 Short- lived $2,100 $1,400 post- bubble $2,000 $1,300 bounce? $1,900 $1,200 $1,800 $1,100 Post- Average Bubble $1,291 $1,700 $1,000 per capita until 1997 $1,600 $900 $1,500 $800 $1,400 $700 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Source: U.S. Census, linked indices to account for changes in classification in 1993. Page 30
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 We believe construction recovery, the productivity factors mentioned and less debt deflation lift employment. Still, we doubt overall U.S. payrolls rise much above the 2007 high of 137.6mm by 2014 (left chart), symbolic of pressure on labor this cycle. We only see the unemployment rate reaching the post-W.W. II average of 5.7% by 2015 (right chart). U.S. Non-farm Payrolls, Jan-1948 to present, with Stifel We see the unemployment rate at year-end 2012 7.6%, Nicolaus forecast to 2015 with more significant imporvement in 2013-15 eventually The picture of a moderate depression 12.0% reaching the post-W.W. II average of 5.7% by 2015 140,000 Total Non-f arm Payrolls, Thousands 130,000 10.0% Stif el Projections 120,000 110,000 8.0% 7.6% 100,000 6.8% 6.0% 6.0% 90,000 5.7% 80,000 4.0% 70,000 60,000 2.0% 50,000 40,000 0.0% Jan-11 Jan-48 Jan-51 Jan-54 Jan-57 Jan-60 Jan-63 Jan-66 Jan-69 Jan-72 Jan-75 Jan-78 Jan-81 Jan-84 Jan-87 Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-14 Jan-11 Jan-48 Jan-51 Jan-54 Jan-57 Jan-60 Jan-63 Jan-66 Jan-69 Jan-72 Jan-75 Jan-78 Jan-81 Jan-84 Jan-87 Jan-90 Jan-93 Jan-96 Jan-99 Jan-02 Jan-05 Jan-08 Jan-14 Source: BEA, U.S. Federal Reserve, Stifel Nicolaus estimates Page 31
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Paper vs. Hard Assets In our view: • We view commodities as a trade. We were negative on hard assets in Apr-11 click, positive Oct-11 click, and negative Apr-12 click. We see late 2012 euro strength and China stimulus lifting commodities. We believe debt tripled U.S. money supply since the mid-1990s, tripling dollar denominated commodities, so CRB fair value is ~20% above recent lows. • We think commodities have completed a “normal” (fourth time in 100 years) ~12 year cycle of beating the S&P 500; this cycle began in 1999. Commodities have followed a classic three-stage “bubble pattern” of investor psychology, and we think prices are due for a “dead cat bounce” of ~20% from the recent low that fails to retake the 2011 high. • Excess returns above GDP progressed from high quality income instruments (bonds, stocks in the 1980s, 1990s) to low or no income assets (houses, commodities in the 2000s). De-leveraging thus slows (or contracts) money supply, undermining commodities. • Given commodity price vulnerability to both nominal (i.e., in reflation) and real (in deflation) rates, we think the coup de grâce for commodities may be Fed exit from 0% rates ~2014/15, however slight the move. Hiking the FFR from lower lows each cycle produces short-rate volatility, and may cause commodity countries/currencies could plunge mid-decade. • Chinese just crossed a critical threshold ($5,000 GDP per capita), which is historically when GDP growth begins to slow (even as income per capita rises), and the mineral intensity of growth also slows sharply. Beyond China, we think the roll- back of Emerging Market fuel subsidy distortions (due to budget woes and weak currencies) slows world oil demand. Page 32
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Commodities periodically beat stocks for ~12 year cycles and this one began in 1999. When commodities beat stocks (excludes dividends) the line moves down. We think 1999-2011 commodity leadership has ended, entering an oscillating phase (red ovals). U.S. Stock Market relative to the Commodity Market, 100.0 Annual, 1870 to July 2, 2012 Intra-day. Key: When the line is rising, the S&P stock market index beats the commodity price index and when the line is falling the opposite occurs. OPEC overplays hand and Relative price strength, stocks vs. commodities, log scale oil prices collapse 1981, Volcker stops inflation 1981-82, Reagan cuts taxes, long Soviet collapse, disinflation & bull market 1980s-90s. 10.0 Post-W.W. 2/Korea commodity inflation bubble bursts, disinflation ensues, 1950s bull market begins. Credit growth expands Post-WW 1 money supply relative Post-Civil War commodity to commodities, post- Reconstruction ends in bubble bursts, 9/11 U.S. $ weakens, 1877, gold standard bull market Mid-East wars, Asian begins 1879, begins. commodity use. deflationary boom, 1.0 stocks rally. OPEC 73 embargo; 1973-74 29 Crash, Guns-and- Bear Populism in U.S. Gold seized Butter 1960s; Market, WW2 politics. U.S.$ devalued 1939-45 Nixon closed Iran fell Panic of 1907, a in 1933. gold window 79, banking crisis & 1971, all Volcker stock market inflationary. tightens. crash. WW1 1914 to 1918 0.1 1870 1875 1880 1885 1890 1895 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 U.S. stock market composite relative to the U.S. commodity market, 1870 to present Source: S&P (Cowles Study), 1870 to 1913 is the WPI for Commodities from the BLS and other agencies. 1914-56 is the PPI All Commodities, and 1957-present is the CRB Continuous Commodity Index, now an equal-weighted index of 17 commodities including most high-use energy & agricultural commodities. Page 33
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Commodities have followed a classic three-stage “bubble pattern” of investor psychology (left chart), and we think prices are due for a “dead cat bounce” that fails to retake the old high. Whether a commodity “bust” or just a slowing depends on China and the dollar, but in either case we see a renewed “secular bear market” (long, flat or down period) for commodities. Commodity Prices (CRB Futures Continuous “SECULAR” BULL Commodity Index)(2) MARKET STAGES(1) Daily prices 08/14/1998 to present 700 DIMINISHING RETURNS BOTTOM TO TOP 650 600 550 Dead cat 500 bounce 450 400 A dead cat bounce to ~600 350 that fails to overtake the April 300 2011 high? 250 200 150 Jul-16, 1999 S&P Source: Stifel Nicolaus. 500 peaks vs. CRB 100 Feb-99 Feb-00 Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Aug-98 Aug-99 Aug-00 Aug-01 Aug-02 Aug-03 Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 (1) We believe secular bear markets cause investors to be “long term” when they should be short-term and opportunistic. Conversely, secular bull markets cause investors to be short term, selling too soon, such as commodities 1999-2011 above (or Tech 1991-2000), when one should be long term and practice buy-and-hold until Source: Stifel Nicolaus, CRB Futures from Factset. the trend fails to over-take the previous high, signaling secular bull market’s end. (2) The CRB CCI is an equal-weighted index of 17 commodities, categorized as follows: 17.64% (each) energy, precious metals & grains; 11.76% livestock; 29.4% “soft” commodities (i.e. sugar, cotton, etc.) & 5.88% copper. Page 34
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 If you triple the unit of account (i.e., U.S. $), you triple commodities denominated in that unit. Asian savings facilitated U.S. credit(1), boosting U.S. money supply ~3x since the 1990s Asia Crisis (left), causing dollar commodity prices to rise ~3x (right). QE + Chinese stimulus boosted commodities 1Q09-2Q11, but we see commodities only tracking M3 money in the future, around ~600 on CRB CCI. M3 money + Excess Reserves at the Fed ($ bil.) Commodity Prices (CRB Futures Continuous $16,000 Commodity Index)(2) Change in M3, excl. excess 2008 Excess Reserves Daily prices 08/14/1998 to present $15,000 reserves (not part of M3) 700 $14,000 Sum = M3 Institutional Money 650 Funds $13,000 $12,000 Eurodollars 600 $11,000 550 Repos $10,000 +3x 500 $9,000 Deng currency Large-Time Deposits reforms in China, 450 $8,000 Mexican Peso & M2 = Below Asian debt crises. Retail Money Funds 400 +3x $7,000 A dead cat bounce to ~600 $6,000 350 that fails to Small Denom. Time Deposits overtake the April $5,000 300 2011 high? $4,000 Savings Deposits 250 $3,000 M1 = Below Demand & Other 200 $2,000 Check Deposits $1,000 150 Currency & Travelers Checks $0 100 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Feb-99 Feb-00 Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Aug-98 Aug-99 Aug-00 Aug-01 Aug-02 Aug-03 Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Source: U.S. Federal Reserve. For M3 1981 to 2005 the Fed reported M3 (SA). For 2006 forward we use: M2 + large time deposits + institutional money market balances + Fed Funds & Reverse repos with non-banks + interbank loans + eurodollars (regress historical levels versus levels of M3 excluding Eurodollars). We also add excess reserves at the Fed to M3, which takes into account funds in surplus over those mandated by reserve requirements. We add them to M3 to better reflect high powered money, but realize the Fed could remove those reserves by selling its liquid assets. (1) Foreign purchases of U.S. Treasuries & Agencies kept U.S. rates low and recycled the trade deficit. As for money creation, when a bank makes a loan and the recipient re-deposits the loan, the bank holds back a ~10% reserve at the Fed and makes another loan. In that way $1 of reserves creates $10 of money supply. 33 (2) CRB Continuous Commodity Index, currently an equal-weighted, front-month index of 17 commodities including most high-use energy, metal and agricultural commodities. Page 35
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Commodity producing and serving equities follow commodity prices, and a bounce in Brent oil to ~$110-$120 could create several correlation trade opportunities, in our view. We compare Freeport McMoRan (left), Caterpillar + Deere (middle) and Oil Service OSX (right) to Brent crude oil. Freeport-McMoRan Copper & Gold Stock Price (Right) vs. CAT + Deere Stock price (Right) PHLX OSX Oil Service Stock Index (Right) $160 Brent Crude Oil (Left) $70 $160 vs. Brent Crude Oil (Left) $240 $160 vs. Brent Crude Oil (Left) $400 $150 $150 $150 $220 $140 $140 $140 $350 $60 $200 $130 $130 $130 $120 $120 $180 $120 $300 $50 $110 $110 $110 $160 $100 $100 $100 $250 $40 $140 $90 $90 $90 $80 $80 $120 $80 $200 $70 $30 $70 $70 $100 $60 $60 $60 $150 $80 $50 $50 $50 $20 $40 $40 $60 $40 $100 $30 $30 $30 $40 $10 $20 $20 $20 $50 $20 $10 $10 $10 $0 $0 $0 $0 $0 $0 2011 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2013 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2013 2011 2011 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012 2013 Source: Factset price history, intraday as of July 2, 2012. Page 36
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 The weak dollar since ~1900 periodically lifted commodities, but we think it was a function of the elastic dollar funding secular, capitalist republican struggles (WW I & II, Cold War, opening China(1), suppressing Extremism). Now the challenge is managing post-conflict deflation (blue line, right). Commodity Price Index, Log Scale Commodity Prices (Left Axis) vs. U.S. M3 Money Supply + 100.00 Data 1805 to July-2012 Excess Reserves at the Fed(1) (Right Axis) The proliferation of Secular, Capitalist Democracy created the illusion of commodities as an asset class, in our view 1913 Fed creation to 2012YTD shown below China stores excess savings as U.S. Cold War Socialism dollars, pegs 14% (1980 peak) (EU, China), 12.0% currency - artificially Communism and boosts gross fixed capital formation World War 2, Radical 11.0% 12% Fascism (only) (commodity intensive) W.W. 1 versions of Colonial Theocracy 10.0% 10% Powers 9.0% Cold War 8% (1980 8.0% peak) 6% 7.0% 10.00 4% 6.0% World War of 1812 World War 2, 2% 5.0% Korean & War 1 Conflict Napoleonic (1920 4.0% Wars (1814 U.S.Civil War peak) (1864 peak) 0% peak) 3.0% -2% 1897 2.0% (low) -4% 1.0% -6% 0.0% 2011 1913 1920 1927 1934 1941 1948 1955 1962 1969 1976 1983 1990 1997 2004 1.00 2015E 2025E 1805 1815 1825 1835 1845 1855 1865 1875 1885 1895 1905 1915 1925 1935 1945 1955 1965 1975 1985 1995 2005 U.S. Commodity Price Index, 10-Yr. Average Annual Growth Rate U.S. Commodity Prices, Annual Averages, Linked Indices U.S. M3 Money + Excess Reserves 10-Yr. Average Annual Growth Rate Source: Commodities 1913 to 1956 is the PPI for All Commodities, and 1957 to present is the CRB Continuous Commodity Index, currently an equal-weighted index of 17 commodities including energy and agricultural. Annual values are the average of CRB CCI values for each month, except for the latest decade, which considers all individual trading days of the year. For M3 1897-1958 we use M1 + vault cash + monetary gold stock + bank time deposits + mutual savings bank deposits + S&L deposits. From 1959-2005 the Fed reported M3 (SA). For 2006-Current we use: M2 + large time deposits + institutional money market + Reverse repos with non-banks + interbank loans + eurodollars (regression-derived). We also add excess reserve s at the Fed to M3, which takes into account funds in surplus over those mandated by reserve requirements. We add them to M3 to better reflect high powered money, but realize the Fed could remove those reserves by selling its liquid assets. (1) Under a classical gold standard, for example, Chinese growth such as that seen the past 20 years would not have been possible because RMB currency appreciation would have slowed Chinese GDP and U.S. credit would not have been available to recycle Chinese savings. Only by having the ability to “store” super-normal growth under a fiat dollar standard was China able to grow at that pace. Page 37
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 We think commodities are vulnerable to 14.0% 12.0% U.S. Bond Market Aggregate Return minus U.S. Nominal GDP y/y% either deflation or modest reflation(1), the 10.0% two most likely outcomes we see. During 8.0% 6.0% a period in which money rates fell to 0% 4.0% 2.0% (chart below), caused by leverage 0.0% Oct-86 Apr-90 Oct-93 Apr-97 Oct-00 Apr-04 Oct-07 Apr-11 Feb-10 Jul-88 Feb-89 Feb-96 Jul-95 Jul-02 Feb-03 Jul-09 May-87 May-94 May-01 May-08 Jun-84 Jan-85 Jun-91 Jan-92 Jun-98 Jan-99 Jun-05 Jan-06 Nov-83 Dec-87 Nov-90 Aug-85 Sep-89 Aug-92 Dec-94 Sep-96 Nov-97 Dec-01 Nov-04 Dec-08 Nov-11 Aug-99 Sep-03 Aug-06 Sep-10 Mar-86 Mar-93 Mar-00 Mar-07 creating and thus debasing money, the -2.0% excess return above GDP (right charts) of S&P 500 Total Return minus assets progressed from high quality 25.0% U.S. Nominal GDP y/y% income instruments (bonds, stocks) to 20.0% 15.0% low income producing assets (houses) 10.0% and finally to zero income commodities. 5.0% 0.0% Oct-86 Apr-90 Oct-93 Apr-97 Oct-00 Apr-04 Oct-07 Apr-11 Feb-89 Feb-10 Jul-88 Feb-96 Jul-95 Jul-02 Feb-03 Jul-09 May-87 May-94 May-01 May-08 Jun-84 Jan-85 Jun-91 Jan-92 Jun-98 Jan-99 Jun-05 Jan-06 Nov-83 Nov-90 Aug-85 Dec-87 Sep-89 Aug-92 Dec-94 Sep-96 Nov-97 Aug-99 Dec-01 Sep-03 Nov-04 Aug-06 Dec-08 Sep-10 Nov-11 Mar-86 Mar-93 Mar-00 Mar-07 10Y Treasury vs. Federal Funds -5.0% Credit debased money by increasing its quantity, leading to lower rates (money had less worth and thus a lower price) that, in turn, -10.0% 11% lowered the bar on income producing assets to include non- income producing commodities. 4.0% FHFA U.S. House Price Index minus 10% 3.0% U.S. Nominal GDP y/y% 2.0% 9% 1.0% 0.0% -1.0% 8% -2.0% -3.0% 7% -4.0% -5.0% 6% -6.0% Nov-83 Aug-85 Dec-87 Sep-89 Nov-90 Aug-92 Dec-94 Sep-96 Nov-97 Aug-99 Dec-01 Sep-03 Nov-04 Aug-06 Dec-08 Sep-10 Nov-11 Oct-86 Apr-90 Oct-93 Apr-97 Oct-00 Apr-04 Oct-07 Apr-11 Mar-86 Feb-89 Mar-00 Feb-10 Jul-88 Mar-93 Feb-96 Jul-95 Jul-02 Feb-03 Mar-07 Jul-09 May-87 May-94 May-01 May-08 Jun-84 Jan-85 Jun-91 Jan-92 Jun-98 Jan-99 Jun-05 Jan-06 5% 4% CRB Futures Commodities Price Index minus 15.0% U.S. Nominal GDP y/y% 10.0% 3% 5.0% 2% 0.0% Fed QE -5.0% plus 1% China -10.0% stimulus "extension" 0% -15.0% 2011 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 -20.0% Nov-83 Dec-87 Nov-90 Dec-94 Dec-01 Nov-04 Dec-08 Aug-85 Sep-89 Aug-92 Sep-96 Nov-97 Aug-99 Sep-03 Aug-06 Sep-10 Nov-11 Oct-86 Apr-90 Oct-93 Apr-97 Oct-00 Apr-04 Oct-07 Apr-11 Mar-86 Feb-89 Mar-93 Mar-00 Mar-07 Feb-10 Jul-88 Feb-96 Jul-95 Jul-02 Feb-03 Jul-09 May-87 May-94 May-01 May-08 Jun-84 Jan-85 Jun-91 Jan-92 Jun-98 Jan-99 Jun-05 Jan-06 Source: Factset, Bloomberg data, Stifel format. (1) We doubt commodities benefit from slowing Emerging Market demand (or the EM rebalancing away from fixed investment), nor from a “sweet spot” of reflationary traction accompanied by excess capacity and de-leveraging that minimize inflation. Commodities appear to need the extremes, and we see a middle ground. Page 38
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Given commodity price vulnerability to rates, we think the coup de grâce for commodities may be Fed exit from 0% rates ~2014/15, however slight the move. Hiking the FFR from lower lows each cycle (left chart) increased short-rate volatility (right chart), contributing to financial crises. If the FFR rises from ~7bps to ~75bps, we think commodity countries/currencies could plunge. The Fed forced the Fed Funds Rate (FFR) to "lower lows" Eventually hiking the FFR from ~7bps to ~75bps would be to achieve a positive spread between the 10Y yield and FFR upwards of a 1,000% change in the FFR, a harbinger of crisis for whose who rely on low cost money, such as 15% commodities in the present era 14% 220% (E) 13% 200% (A) 6/84 peak, Continental Bank fails 180% (B) 3/89 peak, Drexel Burnham, S&Ls fail 12% (C) 12/94 peak, Mexico, Asia/EM debt crisis 160% (D) 6/00 peak, S&P & NASDAQ melt-down 11% 140% (E) 5/05 peak, housing peaks the next year 10% (F) 10/10 peak, EU debt crisis, China slows 120% 9% 100% (C) 8% 80% (F) 60% (B) (D) 7% 40% (A) 6% 20% 5% 0% 4% -20% 3% -40% 2% -60% 1% -80% 0% -100% 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 10-Year Treasury Yield Fed Funds Rate Fed Funds Rate y/y% chg. 10-Year Treasury Yield y/y% chg. Source: Federal Reserve, FactSet. Charts formats and annotations Stifel Nicolaus & Co. Page 39
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Chinese growth is set to become less mineral intensive. Chinese GDP per capita just crossed through $5,000 (green arrow) but that is typically when overall GDP growth begins to slow based on the experience of other Asian countries when their GDP/capita also crossed $5,000 (left chart). After this $5,000 mark (denoted by “T+0” in the charts) the mineral intensity of growth slows (right chart), because growth moves beyond heavy industry. We expect that for China in the coming years. 3 Countrys Average Barrels of Oil Equivalent (Oil + Real GDP Growth per Annum (Blue, LS) vs. Natural Gas) Consumption per Capita, Y/Y Growth % of GDP per capita in U.S. $ (Red, RS) US $ Rate* vs. China 2001-Present GDP Thous. 24.00% 16% $30 22.00% China (2002-2011) China: Y/Y Annualized Growth: Oil Consumption per Capita Real GDP 20.00% Japan (1964-1994) 14% Growth (%) 18.00% Taiwan (1978-2008) 2001-2011 3-Country Avg: $25 Japan 1964-1994 16.00% S. Korea 1980-2010 Korea (1980-2010) 12% 14.00% Taiwan 1978-2008 Real GDP per capita (RS) 12.00% $20 10% 10.00% 8.00% 8% $15 6.00% 4.00% 6% 2.00% $10 China: 0.00% 4% GDP/Capita -2.00% tracking normal 3-Country Avg: -4.00% Japan 1964-1994 $5 2% S. Korea 1980-2010 -6.00% Taiwan 1978-2008 Real GDP y/y % (LS) -8.00% T+0 T+2 T+4 T+6 T+8 T-8 T-6 T-4 T-2 T+10 T+12 T+14 T+16 T+18 T+20 T-10 0% $0 T+0 T+2 T+4 T+6 T+8 T-8 T-6 T-4 T-2 T+10 T+12 T+14 T+16 T+18 T+20 T-10 *Shown smoothed Source: BP Annual Review, IEA, UN, Japanese Ministry of Internal Affairs and Communications, OECD, IMF. (1) Gross National Savings is the sum of the government surplus/(deficit) plus personal savings and corporate savings (retained earnings). Page 40
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 We think non-G7 oil demand is ripe for pull-back as GDP slows and non-G7 oil/fuel subsidy distortions are perhaps rolled back due to budget woes we expect in the Emerging Markets. We think G7(1) oil demand, which is 37% of the world total, is likely to remain weak (left chart), having experienced in 2007-09 an oil shock similar to 1979-81. In contrast, non-G7 oil demand has grown at ~2.9%/yr., is 63% of world oil demand, and is precariously above trend. G7 (U.S., U.K., Ger, Fr, It, Jap, Can) Non-G7 Country Oil Demand, bbl. 000s/day Oil Demand, 1970-2011 (000s bbl.) bbl. 000s/day 1970-2011 (000s bbl.) To flatten 55,000 60,000 37% of world oil demand growing 63% of world oil demand growing 2012-15E, at an average 0.0% y/y growth rate in our view at an average 2.9% growth rate 50,000 55,000 50,000 45,000 45,000 40,000 40,000 35,000 35,000 30,000 30,000 25,000 25,000 20,000 20,000 15,000 15,000 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 Source: EIA, BP Statistical Review, United Nations, IEA, Stifel Nicolaus. (1) G7 is the U.S., U.K., Germany, Japan, France, Italy and Canada. Non-G7 is the remainder of the world. Page 41
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Long-term Equity Outlook In our view: • It is too late for bearish epiphanies…Some 91% of all 10-year periods for the S&P total return the past 176 years were higher than the 10 years ended 2011. Thirteen years without price change discounted the “known unknowns.” • Cyclically averaged P/E ratios (moved forward) vs. S&P 500 total return the past century signal to us that equities have bottomed, and stocks are climbing a “wall of worry” as in all past cycles. • We project a 7% to 9% (non-linear) total return for large cap U.S. equities 2012-2022 (2.25% dividend, 4.75% EPS and 0-2% P/E expansion). • Though Secular Bear Markets serve to de-capitalize equity as a percentage of GDP, we do not assume, as some investors do, that markets must dip to a single-digit P/E ratio as in W.W. 2/Korean Conflict or the 1970s Cold War. • The Dow-to-gold price ratio has followed a three-wave down price pattern since 2000, unwinding the past 20 year equity gains versus gold. We believe gold thrives in deflation and inflation, but not in the “sweet spot” we foresee. • The ~55 year peaks between Kondratiev waves signal a decline in commodity inflation for several years then acceleration 2025-2035, perhaps as the median Baby Boomer dies (high medical expense) and debt is discharged. Page 42
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 It is too late for bearish epiphanies…Some 91% of all 10-year periods for the S&P total return the past 176 years were higher than the 10 years ended 2011. Markets “discount” news in real time, so we think 13 years without any price appreciation discounted all of the “known unknowns.” S&P Stock Market Composite Trailing 10-Year Compound Annual Total Return (Includes Reinvested Dividends) , 12/31/98 22.0% Data 1825 to December, 2011 S&P 500 1,229.23 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 12/31/11 S&P 500 1,257.60 4.0% 2.0% 0.0% Only 16 of the past 176 years had a lower 10-year rolling return than today. -2.0% 1865 1870 1875 1880 1885 1890 1895 1945 1950 1955 1960 1965 1970 1835 1840 1845 1850 1855 1860 1900 1905 1910 1915 1920 1925 1930 1935 1940 1975 1980 1985 1990 1995 2000 2005 2010 Source: “A New Historical Database for the NYSE 1815 to 1925: Performance and Predictability,” Yale School of Management, used with permission. Post-1925 data for stocks are Ibbotson/Morningstar and Standard & Poor’s for large-cap equity. Note that the stock market return includes dividends. Chart format and annotations are Stifel Nicolaus & Co. Page 43
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 Cyclically averaged P/E ratios (moved forward) vs. S&P 500 total return may signal that equities have bottomed. The inverted S&P cyclically adjusted P/E (moved forward 10 years) vs. S&P trailing return supports equities continuing to climb the “wall of worry,” evidenced by the visibly different slopes of the arrows (remember, CAPE is moved forward 10 years). We project a 7% to 9% (non-linear) total return for large cap U.S. equities 2012-2022, shown in yellow. Cyclically Adjusted P/E* Ratio for the S&P 500, moved ahead 10 years (Left, inverted) 0x vs. Trailing 10-year S&P 500 total (price + dividend) return (right, normal scale), 23.0% 1937 to 2022E 21.0% 5x Cyclically Adjusted P/E Ratio, inverted axis 19.0% S&P 500 10-year total return, annualized 17.0% Expected 10x 15.0% S&P 500 trailing 10- 15x 13.0% year return 11.0% in 2022E = 20x 7% to 9%: 9.0% 7.0% 2.25% Yield 25x 5.0% 4.75% EPS 0-2% P/E* 30x 3.0% 7% to 9% 1.0% 35x -1.0% * If P/E rises to CAPE Ratio for S&P 500, moved ahead 10 years, left scale -3.0% 16x by 2022 40x that is 2%/yr. S&P 500 10-year trailing annualized total (price + dividend) return, right scale -5.0% from P/E, if flat at 13.5x 2012 45x -7.0% to 2022 that is 1937 1942 1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017 2022 0% from P/E. * CAPE is inflation-adjusted S&P 500 divided by trailing 10-year average of inflation-adjusted S&P 500 EPS. Post-1988 Operating Earnings are used to remove upward P/E bias derived from leverage. Y1 & Y2 axes above aligned based on a best fit post Jan-1960 to present regression y = -110.12x + 29.229 R² = 0.6899 CAPE is moved forward 120 months to show where the trailing S&P 500 return may be at future dates. Source: Shiller historical data, Standard & Poor’s operating earnings data, Stifel Nicolaus estimates Page 44
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 In this chart we see that Secular Bear Markets serve to de-capitalize equity as a percentage of GDP. Unwinding the NASDAQ Tech Bubble, privatizing many companies and reducing the weight of Financials has brought the line down since 2000. But to assume, as some investors do, that we must dip to W.W. 2 (Point A) or Cold War (Point B) depths, both events that were mortal threats to the U.S., does not seem applicable to us. We do not expect such a threat. Monthly Data 12/31/1924 - 6/30/2012 (Log Scale) Stock Market Capitalization as a Percentage of Nominal GDP Source: Ned Davis Research, Inc. 3/31/2000 = 172.6% 172 172 NDR Estimated value of 3900 U.S. common stocks: $15. 62 trillion 156 U.S. Nominal Gross Domestic Product (latest figure): $15. 47 trillion (Blue Line) 156 Current ratio for 6/30/2012 (solid line): 101. 0 % 142 142 129 129 Value of S&P 500 Index constituents: $12. 30 trillion 118 U.S. Nominal Gross Domestic Product (latest figure): $15. 47 trillion (Red Line) 118 Current ratio for 6/30/2012 (dashed line): 79. 5 % 107 107 98 98 Linear regression trendline value: 89 8/31/1929 = 86.6% (Heavy Dashed Line) 89 6/30/2012 = 90.5% 81 1/31/1973 = 79.4% 81 11/30/1968 = 76.5% 74 11/30/1936 = 71.6% 12/31/1965 = 71.9% Very Overvalued 74 67 67 Norm Since 1925 = 61.0% 61 61 56 56 51 B 51 46 46 42 10/31/1990 = 43.3% 42 38 Very Undervalued 38 35 A 9/30/1974 = 36.3% 35 32 7/31/1982 = 32.2% 32 29 29 NDR Estimated Fixed-Weighted GDP December 1924 - February 1946 26 6/30/1932 = 26.6% Chain-Weighted GDP used after February 1946 26 24 Calculation uses NDR Estimated Com on m Stock Market Capitalization of U.S.-based Companies 24 Dow Jones Total Stock Market Capitalization used fromJanuary 1973 through Septem 1980 ber 22 NYSE Market Capitalization used prior to January 1973 22 20 20 4/30/1942 = 19.4% Concept Courtesy: JimBianco 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 (S702)  Copyright 2012 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. Used with permission/subscriber. See NDR Disclaimer at www.ndr.com/copyright.html . For data vendor disclaimers refer to www.ndr.com/vendorinfo/ . Page 45
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 The current Secular Bear Market has followed a classic three-stage decline in the Dow-to-gold price ratio. The EU debt crisis in 2011 added a follow-on ripple after the post-2009 U.S. capitulation leg, indicating to us that the U.S. wrote the playbook for addressing the crisis, and overcoming eurozone and Chinese resistance to the U.S. prescription of coordinated fiscal and monetary policy responses has been the challenge since the 2009 base began to form. Dow to Gold Ratio Three stage bear NASDAQ and U.S. growth stock bubble market completed peaks. 44 42 40 38 Shock & 36 Disbelief 34 This is the Dow Jones 30 32 Industrials divided by the price 30 of Gold per ounce, monthly 28 since 1982. 26 Acceptance 24 22 20 18 Capitulation 16 14 12 10 8 6 The Dow vs. Gold has been a classic Shock, 4 Acceptance & Capitulation movement. 2 Is golds leadership over? 0 1984 1985 1989 1990 1991 1995 1996 2000 2001 2005 2006 2010 2011 2012 1982 1983 1986 1987 1988 1992 1993 1994 1997 1998 1999 2002 2003 2004 2007 2008 2009 Source: Dow Jones data via Bloomberg and FactSet, Stifel Nicolaus format. Page 46
  • Market StrategyMacro & Portfolio Strategy July 9, 2012 We have our 2025-35 concerns, but there seems to us little incentive to inflate ahead of the Baby Boomer’s liabilities. The ~55 year peaks between Kondratiev peaks and bottoms (chart) signal a decline in commodity inflation to ~2025 while China re-balances and western deflationary private de-leveraging and dollar strength runs its course. Inflation could accelerate after 2025, however, just as the median Boomer dies at great medical expense that decade. It is a working theory. Commodity price inflation follows a Kondratiev Cycle K-Waves peak (and bottom) every ~55 years, with failed peaks in between. On that basis, 2011 is a failed peak, and commodity prices should slow the next 12-15 years to a ~3% growth rate (10-yr. m.a.) before resuming the sharp uptrend 2025-2035E, in our view. 20.0% 55 years 19.0% 18.0% 60 years 17.0% 2035 16.0% peak? 15.0% 56 years 14.0% 1980 peak 13.0% Cold War 50 years 12.0% 1920 peak Est. 11.0% Just after W.W.I path 10.0% 1864 peak 9.0% U.S. Civil 2012- 8.0% War 2035 1814 peak 7.0% War of 1812/ 6.0% Napoleonic 5.0% Wars 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% 1991 2047 bottom? -5.0% 1930 -6.0% 1878 1824 -7.0% 56 years -8.0% 61 years -9.0% 52 years 54 years -10.0% 2025E 2035E 2015E 1805 1815 1825 1835 1845 1855 1865 1875 1885 1895 1905 1915 1925 1935 1945 1955 1965 1975 1985 1995 2005 Source: Commodities 1795 to 1890 are the Warren & Pearson U.S. commodity index constructed with farm products, foods, hides & leather, textiles, fuel & lighting, metals & metal products, building materials, chemicals & drugs, household furnishing goods, spirits and other commodities. 1891 to 1913 is the Wholesale Commodities Price Index from the BLS and other agencies. 1914 to 1956 is the PPI for All Commodities, and 1957 to present is the CRB Continuous Commodity Index, currently an equal-weighted, front-month index of 17 commodities including most high-use energy, metal and agricultural commodities. Prior to 2002, annual data are the average of monthly values. For the trailing decade, all daily closing values for the CRB CCI index are considered. Page 47
  • Market Strategy Macro & Portfolio Strategy July 9, 2012 Important Disclosures and CertificationsI, Barry B. Bannister, certify that the views expressed in this research report accurately reflect my personal viewsabout the subject securities or issuers; and I, Barry B. Bannister, certify that no part of my compensation was, is, orwill be directly or indirectly related to the specific recommendations or views contained in this research report. Forour European Conflicts Management Policy go to the research page at www.stifel.com.Stifel, Nicolaus & Company, Inc.s research analysts receive compensation that is based upon (among other factors) StifelNicolaus overall investment banking revenues.Our investment rating system is three tiered, defined as follows:BUY -For U.S. securities we expect the stock to outperform the S&P 500 by more than 10% over the next 12 months. ForCanadian securities we expect the stock to outperform the S&P/TSX Composite Index by more than 10% over the next 12months. For other non-U.S. securities we expect the stock to outperform the MSCI World Index by more than 10% over thenext 12 months. For yield-sensitive securities, we expect a total return in excess of 12% over the next 12 months for U.S.securities as compared to the S&P 500, for Canadian securities as compared to the S&P/TSX Composite Index, and for othernon-U.S. securities as compared to the MSCI World Index.HOLD -For U.S. securities we expect the stock to perform within 10% (plus or minus) of the S&P 500 over the next 12months. For Canadian securities we expect the stock to perform within 10% (plus or minus) of the S&P/TSX CompositeIndex. For other non-U.S. securities we expect the stock to perform within 10% (plus or minus) of the MSCI World Index. AHold rating is also used for yield-sensitive securities where we are comfortable with the safety of the dividend, but believe thatupside in the share price is limited.SELL -For U.S. securities we expect the stock to underperform the S&P 500 by more than 10% over the next 12 months andbelieve the stock could decline in value. For Canadian securities we expect the stock to underperform the S&P/TSXComposite Index by more than 10% over the next 12 months and believe the stock could decline in value. For other non-U.S.securities we expect the stock to underperform the MSCI World Index by more than 10% over the next 12 months andbelieve the stock could decline in value.Of the securities we rate, 51% are rated Buy, 47% are rated Hold, and 2% are rated Sell.Within the last 12 months, Stifel, Nicolaus & Company, Inc. or an affiliate has provided investment banking services for 15%,12% and 0% of the companies whose shares are rated Buy, Hold and Sell, respectively. Additional DisclosuresPlease visit the Research Page at www.stifel.com for the current research disclosures applicable to the companiesmentioned in this publication that are within Stifel Nicolaus coverage universe. For a discussion of risks to target price pleasesee our stand-alone company reports and notes for all Buy-rated stocks.The information contained herein has been prepared from sources believed to be reliable but is not guaranteed by us and isnot a complete summary or statement of all available data, nor is it considered an offer to buy or sell any securities referred toherein. Opinions expressed are subject to change without notice and do not take into account the particular investmentobjectives, financial situation or needs of individual investors. Employees of Stifel, Nicolaus & Company, Inc. or its affiliatesmay, at times, release written or oral commentary, technical analysis or trading strategies that differ from the opinionsexpressed within. Past performance should not and cannot be viewed as an indicator of future performance.Stifel, Nicolaus & Company, Inc. is a multi-disciplined financial services firm that regularly seeks investment bankingassignments and compensation from issuers for services including, but not limited to, acting as an underwriter in an offeringor financial advisor in a merger or acquisition, or serving as a placement agent in private transactions. Moreover, StifelNicolaus and its affiliates and their respective shareholders, directors, officers and/or employees, may from time to time havelong or short positions in such securities or in options or other derivative instruments based thereon.These materials have been approved by Stifel Nicolaus Europe Limited, authorized and regulated by the Financial ServicesAuthority (UK), in connection with its distribution to professional clients and eligible counterparties in the European EconomicArea. (Stifel Nicolaus Europe Limited home office: London +44 20 7557 6030.) No investments or services mentioned areavailable in the European Economic Area to retail clients or to anyone in Canada other than a Designated Institution. Thisinvestment research report is classified as objective for the purposes of the FSA rules. Please contact a Stifel Nicolaus entityin your jurisdiction if you require additional information. Page 48
  • Market Strategy Macro & Portfolio Strategy July 9, 2012The use of information or data in this research report provided by or derived from Standard & Poor’s Financial Services, LLCis © 2012, Standard & Poor’s Financial Services, LLC (“S&P”). Reproduction of Compustat data and/or information in anyform is prohibited except with the prior written permission of S&P Because of the possibility of human or mechanical error by .S&P’s sources, S&P or others, S&P does not guarantee the accuracy, adequacy, completeness or availability of anyinformation and is not responsible for any errors or omissions or for the results obtained from the use of such information.S&P GIVES NO EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OFMERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE. In no event shall S&P be liable for anyindirect, special or consequential damages in connection with subscriber’s or others’ use of Compustat data and/orinformation. For recipient’s internal use only. Additional Information Available Upon Request© 2012 Stifel, Nicolaus & Company, Inc. One South Street Baltimore, MD 21202. All rights reserved. Page 49