War Room 25 Oct 2012 Eve of Election Update

1. War Room 25 Oct 2012 Eve of Election Update

2. War Room • Monthly macro discussion • Using tools in context • Update on HiddenLevers Features • Your feedback welcome

3. Eve of Election Update • Fiscal Cliff – Brinksmanship Assumed • Housing – Rebound Emerging • III. Europe – Debt Crisis = no. Recession = yes • IV. Scenarios

4. HiddenLevers Fiscal Cliff – Brinksmanship Assumed

5. Fiscal Cliff - Basics • SPENDING CUTS • First spending decline since 1999 • Obama – Stimulus spending = over • Unemployment extensions = over • Teacher + Police earmarks = expired • Fed - Operation twist – over • Debt Ceiling hit end of 2012 • Defense spending cuts – $500b • Discretionary spending cuts– $700b • TAX INCREASES • Bush Tax Cuts – Average family gets $3000 tax hike • Cost of Bush tax cuts expiring over next decade - $4 trillion • Payroll Tax Cuts expire • Medicare tax on high earners (Obamacare) • Estate Tax goes from 35%  55% • Capital Gains + Dividends Tax : 15%  normal income tax rates • Total tax increase: almost $500b TAXMAGEDDON Total Impact of Tax Increases + Spending cuts Total = 5% of GDP

6. Fiscal Cliff – Basics Romney + GOP Congress Status Quo (pipe dream) Romney + Split Congress Romney + Dem Congress Obama + GOP Congress Obama + Split Congress Obama + Dem Congress (pipe dream) exec senate house Obama Dem 53/47 GOP 242/193

7. Fiscal Cliff – Post-Election Behavior Change? “Administration officials have been expressing that confidence for weeks, even as they say no real negotiations are happening.” – NY Times Two thirds of economists assume resolution without damage to economy – USA Today congress since 2010 • Potential Trump Card: • Obama win = clock ticking + some new clout • Defense spending + Bush tax cuts = GOP agenda • Conclusion • Romney wins – lame duck, can kicked into 2013 • Obama wins – worst case more likely, but GOP may buckle Seriously? congress post-election

8. Fiscal Cliff Update – Worst Case Scenario • Advantages of Worst Case Scenario • No sudden economic collapse • Falling market forces government to focus • Deficit Balanced – automatic austerity • Disadvantages • Long term effects of belligerent parties • Recession very likely – 5% hit to GDP • 1840s – worse than Thelma + Louise • Disagreement between north + south on tariffs on Euro goods • 1830 agreement that in 10 years tariffs would be eliminated (Think Bush Tax Cuts) • 1838 major financial crisis after boom • 1840 US sliding into deep depression • 1842 1/3 of states defaulted on foreign loans • President Tyler cabinet resigned • The Deal: • John Tyler vetoed bills to keep high tariffs • Original bargain struck 10 years before abandoned • Tariff preserved but way lower • Southern states seething led to secession/war

9. Fiscal Cliff Update – Effect on USD + Treasuries Dollar Rally in Fiscal Cliff MACRO: Flight to dollar as safety FUNDAMENTALS: Lower Deficit = Stronger USA Rally in US Treasuries 2011 Counter-intuitive – 10y integrity 2012: Intuitive – stronger USA

10. HiddenLevers Housing – Rebound Emerging

11. Housing - Competing Trends: Long Term Home Prices - Downward

12. Housing - Competing Trends: Affordability NAR Affordability Index • Affordability is highest in decades • Historically low mtg rates + price declines • 75% of homes sold now affordable to median income buyers • In many markets buying < renting NAHB Housing Opportunity Index Sources: National Associations of Realtors, Home Builders, and Wells Fargo

13. Housing - Competing Trends: Home Sales + Construction Upward US home sales + new housing construction starts both rising since bottom in early 2011 Source: HiddenLevers Home builders' confidence and stock prices soaring over last 2 years

14. Housing - Competing Trends: Home Price + Foreclosure Issues Remain Residential foreclosures remain high + existing home sales trend much weaker than new home sales Source: HiddenLevers Low mortgage rates + low home prices = affordability But home prices continue to drag on household wealth

15. Housing Update – Rebound Emerging Consequences: S+P to new highs, but muted impact from here 2. Industrial commodities will benefit most Employment picture change will be cause Rebound will in turn affect employment in sector • Consequences: • Home prices may suffer up to 30% more downside • Good chance of US economy going into recession • Pendulum’s don’t stop in the middle • Home ownership dies as an American tradition

16. HiddenLevers Europe – Debt Crisis = no. Recession = yes.

17. Europe – Basics Source: HiddenLevers S&P + Euro continue to move in lockstep, up + down over 3 months

18. Europe Update – Draghi commitment ECB pledged unlimited bond purchases to Spain Spain bond yields have fallen considerably since early Sept ECB interventions key to this decrease Spain default = Euro Zone Pulse of banking crisis rests on this lever, no matter what drama is in news Spanish Bonds – 10Y Benchmark Yields Source: Bloomberg

19. Europe Update – Now in Recession US big caps pulling out of Europe  no more diapers  plant shut downs  $15b out of EU banks • ECB intervention = buying time • ECB so far unwilling to engage in QE a la Fed • European austerity policies failed to deliver growth • Even German economy sliding now

20. Europe Update – Why no action? • Significance • Greek economy shrunk almost 20% since peak • Unemployment in Greece at 25% = Depression levels • Unemployment in Germany at 5% = Germans not feeling pinch Source: Economist

21. Europe Update – Greece Defaulted, did not Exit Guidance Greek default + Euro exit almost fully priced in Well handled, with guidance and action = rally Proof - Gold is a commodity, not a reserve currency 5. Think GM, Bear Stearns • Guidance • Spain default or other PIIGS follow Greece out • Poorly handled, with no plan of action = bloodbath • At risk – anything priced in US Dollars • Defending Euro/Swiss Peg will be difficult • Think Lehman

22. HiddenLevers Scenarios

23. HiddenLevers – Product Update • iPad app now in App Store – very beta • House-holding of portfolios • Advanced Analytics – multiple time frames • Coming soon– Integrations: • Schwab Portfolio Center • Money Guide Pro • Fortigent