Second Annual Investment Symposium Presenting our outlook for the economy and markets. The Chattanoogan Hotel Tuesday, February 8, 2011 All market data provided by Bloomberg unless otherwise indicated. 1
Review of the First Annual Investment Symposium 2010 Scorecard Interest rates remain low Equities outperform bonds Volatility to remain high Global credit concerns Fed to begin exit B B A A C 2
Are you a Cassandra or a Pollyanna? Cassandra: somebody with prescience but cursed because no one believes her predictions. This term is often applied to investors who communicate negative portents about the markets. The glass is half empty. Pollyanna: somebody with naïve and eternal optimism. This term is often applied to investors whose optimism is so excessive that they fail to identify situations that are unsustainable. The glass is half full. 3
Cassandra says Beware the printing of money by global central banks. Beware the hyperinflationary effects of our monetary policy. Beware our dependence on China to finance our debt. Beware the collapse of the European Union. Beware our deficits and debt. Beware the Fed. 4
The Fed The US central bank responsible for the design and implementation of our monetary policy. The Fed is also the primary regulator of the US banking system. Dual mandate: full employment and price stability. Retaining independence is vital to preserving the credibility of the Fed. 5
Scylla & Charybdis 6
Between a Rock and a Hard Place 7
Quantitative Easing S&P 500 Performance since Lehman bankruptcy 1350.00 S&P 500 Lehman QE1 ends 1250.00 1150.00 1050.00 950.00 850.00 750.00 650.00 9/2/2008 10/2/2008 11/1/2008 12/1/2008 12/31/2008 1/30/2009 3/1/2009 3/31/2009 4/30/2009 5/30/2009 6/29/2009 7/29/2009 8/28/2009 9/27/2009 10/27/2009 QE1 launched 11/26/2009 12/26/2009 1/25/2010 2/24/2010 3/26/2010 4/25/2010 5/25/2010 6/24/2010 7/24/2010 8/23/2010 9/22/2010 10/22/2010 11/21/2010 12/21/2010 1/20/2011 QE2 8
Impact of QE Interest rates remain exceptionally low for an extended period. Negative for savers; positive impact from wealth effect. Puts pressure on the Dollar; provides support for equities. 9
The Impact of a weak Dollar Dollar Index vs. Core CPI Inflation since 2002 120.00 6.0 110.00 Dollar Index 5.0 Dollar Index 100.00 90.00 80.00 70.00 12/31/2001 5/20/2002 10/7/2002 2/24/2003 7/14/2003 12/1/2003 4/19/2004 9/6/2004 1/24/2005 6/13/2005 10/31/2005 3/20/2006 8/7/2006 12/25/2006 5/14/2007 10/1/2007 2/18/2008 7/7/2008 11/24/2008 4/13/2009 8/31/2009 1/18/2010 6/7/2010 10/25/2010 Core CPI 4.0 3.0 2.0 1.0 - CPI ex-food & Energy 10
Core versus Headline Inflation 10 year Chart of Consumer Inflation 6.0 5.0 CPI CPI Core 6.0 5.0 Consumer Price Index 4.0 4.0 3.0 3.0 2.0 2.0 1.0 1.0 - - 1/3/2000 5/22/2001 10/8/2002 2/24/2004 7/13/2005 11/30/2006 4/18/2008 9/3/2009 1/20/2011 (1.0) (1.0) CPI ex-food & Energy (Core) (2.0) (2.0) (3.0) (3.0) 11
Contributing Factors to Inflation Change in Non Farm Payrolls since January 2008 Monthly Change in Non Farm Payrolls 600,000 500,000 400,000 300,000 200,000 100,000 - (100,000) (200,000) January-08 (300,000) (400,000) (500,000) (600,000) (700,000) (800,000) (900,000) February-08 March-08 April-08 Chg Non Farm Payrolls Cumulative May-08 June-08 July-08 August-08 September-08 October-08 November-08 December-08 January-09 February-09 March-09 April-09 May-09 June-09 July-09 August-09 September-09 October-09 November-09 December-10 January-10 February-10 March-10 April-10 May-10 June-10 July-10 August-10 September-10 October-10 November-10 December-10 January-11 (250,000) (750,000) (1,250,000) (1,750,000) (2,250,000) (2,750,000) (3,250,000) (3,750,000) (4,250,000) (4,750,000) (5,250,000) (5,750,000) (6,250,000) (6,750,000) (7,250,000) (7,750,000) (8,250,000) (8,750,000) Cumulative Change in Non Farm Payrolls 12
When to get worried about inflation? 14.5 million unemployed in the US. 6.4 million (44%) unemployed for more than 27 weeks. In order for unemployment to fall below 8% this year, 215,000 net new jobs per month. In order for unemployment to fall below 7% this year, 368,000 net new jobs per month. Source: Bureau of Labor Statistics (as of December 2010). 13
Bond Market through the Crisis 10yr TSY Yield since July 2007 5.5 4.5 QE1 Ends Yield 3.5 2.5 1.5 ZIRP QE1 Launched QE2 Announced & Launched 7/2/2007 9/2/2007 11/2/2007 1/2/2008 3/2/2008 5/2/2008 7/2/2008 9/2/2008 11/2/2008 1/2/2009 3/2/2009 5/2/2009 7/2/2009 9/2/2009 11/2/2009 1/2/2010 3/2/2010 5/2/2010 7/2/2010 9/2/2010 11/2/2010 1/2/2011 Date 14
Bond Market Outlook No need to panic. ZIRP remains in place throughout 2011, other Fed actions possible. Expect long rates to continue to normalize while short rates stay low. Prefer credit risk over duration risk. Fears of a mass wave of municipal defaults are overdone. 15
Normalization? 10yr TSY Yield vs Core CPI 6 10yr TSY Core CPI 5 4 3 2 1 0 1/1/01 7/1/01 1/1/02 7/1/02 1/1/03 7/1/03 1/1/04 7/1/04 1/1/05 7/1/05 1/1/06 7/1/06 1/1/07 7/1/07 1/1/08 7/1/08 1/1/09 7/1/09 1/1/10 7/1/10 1/1/11 % 16
Impact of Rising Rates Expected Bond Market Returns Total Return 20 15 10 5 0-5 -10 16.72 12.51 7.93 3.31-300bp -200bp -100bp No Change (0.99) (4.84) (8.31) 100bp 200bp 300bp 17
Muni Facts & Figures 55,000+ municipal issuers with $2.8 trillion outstanding. 200 bond deals ($6.9 billion par) in default at 12/31/10; mostly IDR, Healthcare, & Multi-Fam Hsg. Debt service payments are less than 5% of the avg. municipal budget. Other risks to consider. Opportunities exist; after-tax rates are attractive. 18
Taxable Equivalent Yields 8 7 6 5 4 3 2 1 0 2yr 10yr 20yr 30yr Treasury 1/31/11 AAA Municipal 1/31/11 19
Factors that Drive Stock Performance 1. Valuation 2. Dividends 3. Earnings Growth 4. Multiple Expansion/Contraction 20
Why Stocks Now 1. Asset class rotation from bonds to stocks. 2. Low interest rate and low inflation environment 3. Reasonable valuations 4. Stocks as income vehicles 5. Strength of corporate balance sheets 6. Solid prospects for continued earnings growth 21
Mutual Fund Flows Source for data: ICI.org. Annual Net Mutual Fund Flows: 1995-2010 (in m illions) $400,000 Stock Bond $300,000 $200,000 $100,000 $0 ($100,000) 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 ($200,000) ($300,000) 22
Fund Flows 2010 Monthly Source for data: ICI.org. 2010 Monthly Net New Mutual Fund Flows (in millions) $40,000 To tal Sto ck Taxable Bo nd $30,000 $20,000 $10,000 $0 ($10,000) Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 ($20,000) ($30,000) ($40,000) 23
Valuation: S&P 500 Historical P/E S&P 500 Historical P/E Ratio: 1970 to present 35.0x 30.0x 25.0x 20.0x 15.0x 10.0x 5.0x Feb-70 Nov-71 Aug-73 May-75 Mar-77 Dec-78 Sep-80 Jun-82 Apr-84 Jan-86 Oct-87 Jul-89 May-91 Feb-93 Nov-94 Aug-96 Jun-98 Mar-00 Dec-01 Sep-03 Jul-05 Apr-07 Jan-09 Oct-10 24
S&P 500: Relative Valuation Source: Bank Credit Analyst, February 2011. Shiller P/E and 10-year Annualized Returns 20% 15% % Return 10% 5% 0% -5% Less than 10 10 to 20 20 to 30 30 to 40 More than 40 P/E Quintiles 25
Stocks = Source of Income 10 Year Dividend Company Bond Yield Yield AT&T 4.16% 6.04% Verizon 4.28% 5.29% Duke Energy 4.20% 5.37% Merck 3.96% 4.62% Dominion 4.20% 4.19% Lockheed Martin 4.71% 3.27% Chevron 3.45% 3.00% JP Morgan Chase 4.78% 0.44% 26
S&P 500 Sector Performance/Rotation 2002 2003 2004 2005 2006 2007 2008 2009 2010 S&P 500-22.15 S&P 500 28.62 S&P 500 10.92 S&P 500 4.88 S&P 500 15.80 S&P 500 5.48 S&P 500-37.00 S&P 500 26.46 S&P 500 14.17 Healthcare -1.5% Consumer 36.3% Energy 31.8% Energy 38.5% Consumer 17.5% Energy 37.1% Staples -17.1% Tech 48.8% Consumer 25.7% Materials -7.4% Tech 37.7% Utilities 20.0% Utiltites 12.8% Energy 16.5% Materials 19.8% Healthcare -24.8% Materials 45.7% Industrials 25.5% Financials - 16.4% Materials 34.8% Industrials 16.1% Healthcare 5.1% Utilities 16.3% Utilities 15.3% Utilities -31.4% Consumer 38.0% Energy 19.7% Energy -16.4% Industrials 30.0% Consumer 12.1% Financials 3.7% Financials 16.0% Industrials 12.4% Consumer -34.0% Industrials 25.7% Materials 16.4% Consumer - 19.2% Financials 27.9% Materials 11.6% Materials 1.2% Tech 11.3% Staples 10.3% Energy -39.8% Energy 19.3% Staples 10.7% Staples -21.5% Utilities 21.8% Financials 8.5% Industrials 1.1% Materials 15% Healthcare 5.4% Tech -42.2% Healthcare 17.0% Financials 10.7% Industrials -25.7% Energy 13.4% Staples 6.0% Staples 0.9% Staples 12.1% Tech 14.6% Industrials -42.9% Financials 15.0% Tech 9.8% Utilities -31.9% Healthcare 13.6% Tech 3.6% Tech -1.0% Industrials 11.4% Consumer -14.8% Materials -45.5% Staples 10.9% Healthcare 1.38% Tech -38.3% Staples 9.2% Healthcare 0.1% Consumer -7.5% Healthcare 5.6% Financials -21.2% Financials -56.7% Utilities 6.9% Utilities 1.0% 27
Partner or Threat? 28
US v. China US China Fiscal Situation Worsening Stable Fiscal Policy Expansionary Moderating Monetary Policy Exceptionally Loose, but Loose Tightening Inflation ST -- Deflation ST -- Inflation LT -- Concerning LT --???? 29
Where to invest Accelerating Moderate Pernicious Inflation (Dis)inflation Deflation TIPs Corporate bonds Treasury Bonds Commodities Equities High quality corporate bonds Non-Dollar exposure Real Estate Defensive, dividend paying stocks Cash Global Infrastructure 30
For our 3 rd Annual 2011 Forecast Interest rates begin to rise Equities outperform bonds US outperforms International Global credit issues less severe Inflation fears alter policy 31