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  1. Black Swans, Volatility and Safe Harbors SUFRA 43rd Financial Forum Washington DC - April 2011 Dr. Scott B. MacDonald Head of Credit and Economics Research Aladdin Capital Holdings, LLC

  2. U.S. Credit Markets Past, Present and Future

  3. An Extended Season of Black Swans 2010 April – May: Greek tremors / EU/IMF agreement on May 2. September : Mozambique food riots mark return of food-related concerns. November : Ireland goes to EU/IMF protests against austerity in Europe(Portugal general strike). 2011 January: European sovereign debt jitters continue. Tunisia’s Jasmine Revolution (President Ben Ali ousted Jan. 14th). Riots occur in Yemen, Bahrain, Oman. February: Egypt’s Mubarak Resigns (February 11th). Riots begin in Libya and turn into civil war. March: Earthquake hits Japan (March 11th). Tsunami/Nuclear Problems follow. Baden–Wurttemberg elections. Saudi intervention into Bahrain. Jasmine Revolution spreads to Syria. April: Oil at $110 a barrel. Portugal goes to IMF/EU for help. U.S. budget follies intensify. Focus turns to Spain?

  4. Key Factors for 2011 • Volatility is likely to be a major factor for both credit and equity markets. • Interest rates likely to remain low, but pressure will mount for a rate increase. • Companies will look to be more shareholder friendly, pushing stock buy-backs, dividend increases, and strategic acquisitions. • Barring any major crisis, investors in credit markets will reach to lower-rated credits to find yield. • Why?

  5. The U.S. Macro Environment • The U.S. economic recovery continues and gains momentum (3.5% real GDP* for 2011). • QEII and Bush tax cut extensions functioned as a massive stimulus ($1 trillion). • Restructuring and deleveraging of the economy continues. • Corporate sector is growing. • Unemployment is set to stay high, though has probably peaked and the trend is our friend. • Bank lending is gradually recovering. • Housing eventually stabilizes. • Exports remain a strong point but could decline due to slower global growth in Europe. • *Aladdin Capital Economic Forecast

  6. Potential Black Swans, Part 1? • Washington becomes gridlocked over fiscal deficit / public sector debt issues. • Bank lending remains weak; stalls growth. • Municipal bond market hit by rising defaulters could turn into larger crisis. • A Fannie Mae / Freddie Mac emergency. • Inflation spills / Fed policy lags

  7. Potential Black Swans, Part 2? • New stress tests unconvincing. • Europe’s sovereign problems continue. Spain? Belgium? Italy? • German elections reduce commitment to E.U. • China’s inflation problems become more severe. • North Korea initiates a war (maybe the ultimate Black Swan). • The BRIC bonanza comes to a halt. • Another Middle East war (Iran/Saudi Arabia/Bahrain/US).

  8. The Credit Landscape – The Most Likely Scenario • Most of what could go wrong, does not. • However, ongoing uncertainty will translate into volatility. • Leaves an investment environment of risk-on/risk off. • Some investors will look to safe harbors. • Significant investor cash keeps any investment grade (IG) and high yield (HY) spread widening contained.

  9. U.S. corporate health is strong • Large companies are likely to remain profitable through 2011. • Cash build-ups are slowing, but if economic momentum picks up there could be more M&A and LBO activity, dividend raises, and stock buy-backs. • Corporate cash flow could help stimulate growth and put 2011 on a better-than-expected track. • U.S. default rates fell to 2.9% in March 2011*. They could fall further in 2011. • Low interest rate environment to continue through the first half of 2011, but outlook could change in late 2011. • The second half of 2011 should see continued growth, contingent upon housing, employment, and business spending. • Many high yield companies have taken advantage of the open bond market to refinance, reducing the repayment mountain. • * Moody’s trailing twelve-month global speculative-grade default rate

  10. Volatility will remain in equity markets. • VIX: Volatility Index • *Source: Bloomberg

  11. Headline risk keeps a lot of cash on the sidelines. • Money Stock: Savings Deposits, including Money Market Deposit Accounts (SA, Bil $) • Source: Federal Reserve Board/Haver Analytics

  12. Conclusion • Uncertain global and U.S. risk factors stay part of the landscape. • Low interest rate environment to continue in the first half of 2011, but pressure is mounting for rate hikes. • Cash is safe, but very low returns. • Bank lending remains anemic (both in the U.S. and Europe). • U.S. credit markets offer a relative safe harbor from volatility and uncertainty in other regions. Utilities still function as a safe harbor.

  13. Biography Dr. SCOTT MACDONALD, Principal, Head of Credit and Economic Research Dr. MacDonald has an extensive background in credit and economics, having worked at the U.S. Comptroller of the Currency, Credit Suisse, and Donaldson, Lufkin and Jenrette. His experience covers banks, commodity companies, energy, sovereigns, and emerging markets. From 1995 through 1999 he was consistently rated as one of the top fixed income analysts by Institutional Investor. Dr. MacDonald is widely published on international economic and financial issues with sixteen books to his credit. He received his Ph.D. in Political Science from the University of Connecticut, an MA in Asian Studies from the University of London’s Oriental and African Studies Department, and a BA in Political Science (with Honors) and History from Trinity College.

  14. Disclaimer This document was prepared by Aladdin Capital Management LLC, and reflects the current opinion of the contributor. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This document is for informational purposes only and does not constitute a solicitation or an offer to buy or sell any investment security, nor provide investment advice. Neither Aladdin Capital Management LLC nor any officer or employee of Aladdin Capital Management LLC or any affiliate thereof accepts any liability whatsoever for any direct, indirect or consequential damages or losses arising from any use of this report or its contents. No part of this document may be reproduced in any manner without the permission of Aladdin Capital LLC.