Market strategy

Barry B. Bannister, CFA [email protected] (443) 224-1317

Stifel Nicolaus Equity Trading Desk US: (800) 424-8870 Canada: (866) 752-4446

Market Commentary/Strategy

Stifel 3Q12 Macro: 1,600 S&P 500 in 2012 on 2H GDP Traction & Policy Moves

We 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: $1,354.68

In Our View

U.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.

July 9, 2012

Market StrategyMacro & Portfolio Strategy

Stifel 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.

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

Our 2Q12 Outlook click harbored mid-2012 growth concerns, and noted the S&P 500 had little upside.

On May 29 click we raised our 2012 S&P 500 view to 1,600 and a spring-loaded market remains our view.

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

Apr-2, 2012

S&P 500 1,419.04

May 29, 2012

S&P 500 1,332.42

Recapping our views at the end of each quarter in 2012:

Page 3


https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=c3aea09d-920f-4235-a3ff-892ff941ce55&mime=html&co=Stifel&[email protected]&source=libraryView

https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=c3aea09d-920f-4235-a3ff-892ff941ce55&mime=html&co=Stifel&[email protected]&source=libraryView

https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=e51ca0f1-a37d-4bba-991d-dffea649fb62&mime=html&co=Stifel&[email protected]&source=libraryView

https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=e51ca0f1-a37d-4bba-991d-dffea649fb62&mime=html&co=Stifel&[email protected]&source=libraryView

https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=59f3b83d-8676-4db4-a6b4-74687c1f2499&mime=html&co=Stifel&[email protected]&source=libraryView

https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=59f3b83d-8676-4db4-a6b4-74687c1f2499&mime=html&co=Stifel&[email protected]&source=libraryView

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.

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.

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)…………………………………………2.9% Consumer Services (Media, restaurants, lodging)………………………………………………………………….3.2%

Health Services………………………..………………………………………………….2.6% Health Services………………………..………………………………………………….-0.5%

Retail Trade……………………………………………………………………..0.6% Process Industries (Chemical, ag, paper)…………………………………………-0.8%

Distribution Services……………………………………………………………………..-1.8% Distribution Services……………………………………………………………………..-0.9%

Commercial Svcs (Fin'l. pub., personnel, advertising)……………………………………………………………………..-2.4% Energy Minerals……………………..………………………………………………….-1.4%

Health Technology………………………………………………….………………………………………………….-3.0% Commercial Svcs (Fin'l. pub., personnel, advertising)……………………………………………………………………..-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……………………..………………………………………………….-9.6% Banks & Financial Services………………………………………………….………………………………………………….-7.0%

Utilities………………..…………………………………………………………..-13.9% Consumer Durables…………………………………………………….-8.6%

---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

KEY:

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"

CORE GROUPS TRADING GROUPS

1Q12 Relative Total Return 2Q12 Relative Total Return

"Risk On" Reflation Confidence "Risk Off" Deflation Fear

3Q12

view

Page 4


1

10

100

1,000

10,000

1895

1900

1905

1910

1915

1920

1925

1930

1935

1940

1945

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

No

min

al S

&P

500

Nominal S&P 500 (S&P Composite before the existence of the S&P 500) - Chart is through June 2012

1907 to1921 1929 to

1949

1968 to1982

2000 toPresent

600

700

800

900

1000

1100

1200

1300

1400

1500

1600

06/0

1/9

8

12/0

1/9

8

06/0

1/9

9

12/0

1/9

9

06/0

1/0

0

12/0

1/0

0

06/0

1/0

1

12/0

1/0

1

06/0

1/0

2

12/0

1/0

2

06/0

1/0

3

12/0

1/0

3

06/0

1/0

4

12/0

1/0

4

06/0

1/0

5

12/0

1/0

5

06/0

1/0

6

12/0

1/0

6

06/0

1/0

7

12/0

1/0

7

06/0

1/0

8

12/0

1/0

8

06/0

1/0

9

12/0

1/0

9

06/0

1/1

0

12/0

1/1

0

06/0

1/1

1

12/0

1/1

1

06/0

1/1

2

Phases of a Secular Bear Market - The S&P 500 (1,362 as of 06/29/12)

Mature BullEarlyBull

LateBull

Bear Market

Early Bull Mature Bull

Defensive OversoldStocks

Multiple 200dmacrosses

Momentum Defensive OversoldStocks

Late Bull

Momentum

LateBull

Bear Market

Source: Stifel Nicolaus estimates, Standard & Poors, Factset

prices.

Est.

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).

Page 5


0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

13.0%

14.0%

15.0%

16.0%

S&P 500 Earnings Yield minus 10-Yr. Risk Free U.S. Government Bond Yield...

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Jan-6

2

Jan-6

4

Jan-6

6

Jan-6

8

Jan-7

0

Jan-7

2

Jan-7

4

Jan-7

6

Jan-7

8

Jan-8

0

Jan-8

2

Jan-8

4

Jan-8

6

Jan-8

8

Jan-9

0

Jan-9

2

Jan-9

4

Jan-9

6

Jan-9

8

Jan-0

0

Jan-0

2

Jan-0

4

Jan-0

6

Jan-0

8

Jan-1

0

Jan-1

2

...Equals the Equity Risk Premium

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).

Source: FactSet Prices, Moody’s Economy.com data, Stifel Nicolaus format

S&P 500 forward EPS consensus ~$109 (the

avg. of 2012-13E) already embeds a sharply

slowing Durable Goods y/y percent change.

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

Jan-9

3

Jan-9

4

Jan-9

5

Jan-9

6

Jan-9

7

Jan-9

8

Jan-9

9

Jan-0

0

Jan-0

1

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1

Jan-1

2

Jan-1

3

Jan-1

4

S&P 500 Operating Earnings (Left Axis) vs. Durable Goods New Orders (Right Axis),

Y/Y % Changes, Jan-93 to Present

S&P 500 Operating Earnings

Durable Goods: New Orders, y/y % 3 mo. avg.

Truncated at 50%

earnings growth

S&P Consensus

Ests.$103.75 '12E$114.28 '13E

A 2012E S&P 500 P/E ~16X (6.25%

Earnings Yield) and 10Y ~2.75% would

narrow the Equity Risk Premium to 3.5%.

X

X

Page 6


-7.0%

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

13.0%

14.0%

15.0%

16.0%0X1X2X3X4X5X6X7X8X9X

10X11X12X13X14X15X16X17X18X19X20X21X22X23X24X25X26X27X28X

19

11

19

16

19

21

19

26

19

31

19

36

19

41

19

46

19

51

19

56

19

61

19

66

19

71

19

76

19

81

19

86

19

91

19

96

20

01

20

06

20

11

P/E of the S&P 500, 5-Yr. Moving Avg. (Left)

U.S. CPI Inflation, Y/Y % Chng., 5-Yr. Moving Avg. (Right, INVERTED)

U.S. Consumer Price Inflation (Inverted, Right Axis) vs. S&P 500 P/E Ratio (Left Axis), 100 Years

An S&P 500 5-year average P/E of 17x is applicable to ~2% annual inflation.

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.

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.

Median % of months

S&P P/E ratio since Jan-1870

at that level in that range of

(Deflation)/ of deflation/ (Deflation)/

Inflation inflation Inflation

(10.0)% + 14.1x 3.5%

(9.0)%-(9.9)% 14.0x 1.5%

(8.0)%-(8.9)% 16.6x 1.1%

(7.0)%-(7.9)% 13.1x 1.3%

(6.0)%-(6.9)% 12.8x 1.6%

(5.0)%-(5.9)% 13.8x 2.6%

(4.0)%-(4.9)% 15.6x 2.2%

(3.0)%-(3.9)% 14.7x 1.4%

(2.0)%-(2.9)% 14.8x 2.9%

(1.0)%-(1.9)% 14.8x 3.6%

(0.1)%-(0.9)% 12.5x 2.6%

0.0% 14.9x 3.6%

0.1%-0.9% 12.6x 3.3%

1.0%-1.9% 17.1x 13.0%

2.0%-2.9% 17.2x 13.0%

3.0%-3.9% 15.9x 12.2%

4.0%-4.9% 15.1x 6.5%

5.0%-5.9% 15.0x 4.3%

6.0%-6.9% 11.3x 4.0%

7.0%-7.9% 12.0x 2.7%

8.0%-8.9% 11.8x 1.7%

9.0%-9.9% 9.2x 2.2%

>10.0% 9.0x 9.1%

100.0%

W.W. I

W.W. II Cold

War

Post-war deflation is

destructive to EPS, leading

to higher P/E ratios

Wartime inflation is destructive to P/E ratios

(but not EPS), leading to lower P/E ratios.

Optimal P/E at

inflation ~2%

Page 7


http://www.econ.yale.edu/

http://www.econ.yale.edu/

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

1Q

19

47

1Q

19

51

1Q

19

55

1Q

19

59

1Q

19

63

1Q

19

67

1Q

19

71

1Q

19

75

1Q

19

79

1Q

19

83

1Q

19

87

1Q

19

91

1Q

19

95

1Q

19

99

1Q

20

03

1Q

20

07

1Q

20

11

% o

f G

DP

Reduced "Investment" spending (i.e., housing) led to large deficits to support GDP

Net Private Investment Net Gov't Saving/(Deficits if >0%)

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%10%

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

21%

22%

23%

1Q

1985

1Q

1987

1Q

1989

1Q

1991

1Q

1993

1Q

1995

1Q

1997

1Q

1999

1Q

2001

1Q

2003

1Q

2005

1Q

2007

1Q

2009

1Q

2011

1Q

2013

Real Fed Funds Rate (FFR), Advanced 5 Qtrs (Red, Right) vs. Corporate Profit Margins (Blue, Left)

1985 - Current

Corporate Profit Margins (Left)

Real Fed Funds Rate (Inverted, Right)

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.

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.

We think margins are

~500bps elevated, but

margins and S&P returns

are not well correlated.

Weak housing (a part of “Net Investment” below) has

been offset by deficits that “prop-up” GDP. Fed commitment to a negative real Fed Funds (Fed

Funds minus y/y inflation) has boosted margins(1).

INV

ER

TE

D A

XIS

Page 8


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.

Source: Bloomberg, Factset data, Stifel Nicolaus format.

$600

$700

$800

$900

$1,000

$1,100

$1,200

$1,300

$1,400

$1,500

$1,600

$1,700

$1,800

$1,900

$2,000

Jan

-06

Jul-0

6

Jan

-07

Jul-0

7

Jan

-08

Jul-0

8

Jan

-09

Jul-0

9

Jan

-10

Jul-1

0

Jan

-11

Jul-1

1

Jan

-12

Jul-1

2

Jan

-13

S&P 500 vs. S&P 500 Ex-Financials (Rebased), Jan-06 to present

S&P 500

S&P Ex-Financials (Rebased)

1.40%

1.90%

2.40%

2.90%

3.40%

3.90%

4.40%

4.90%

5.40%

40.0

45.0

50.0

55.0

60.0

65.0

70.0

75.0

80.0

85.0

90.0

95.0

100.0

Jan

-07

May-0

7

Sep

-07

Jan

-08

May-0

8

Sep

-08

Jan

-09

May-0

9

Sep

-09

Jan

-10

May-1

0

Sep

-10

Jan

-11

May-1

1

Sep

-11

Jan

-12

May-1

2

Sep

-12

US Major and Regional Banks Relative to S&P500, Total Return (Black, Left) vs. US Constant Maturity 10-Yr

Treasury Yields (Red, Right),Jan-2007 to Present

Banks Relative to S&P500 (Left)

U.S. 10-Yr. Treasury Yield (Right)

Nov. 25, 2008 Fed

announces asset

purchase plans,

doubles up Mar-09.

QE1 QE2

GDP

traction

+ Fed

policy

~2.75%

10Y?

Aug. 26,2010

Jackson Hole

Fed QE2 hint.

X

Page 9


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.

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.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

130%

140%

150%

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

Annual gap: best minus worst S&P sector

Other than crisis years, the gap is usually ~40%-50%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1Q

00

4Q

00

3Q

01

2Q

02

1Q

03

4Q

03

3Q

04

2Q

05

1Q

06

4Q

06

3Q

07

2Q

08

1Q

09

4Q

09

3Q

10

2Q

11

1Q

12

S&P 500 Income from Continuing Operations by Sector

Utilities

Telecom. Services

Materials

Info. Tech.

Industrials

Health Care

Financials

Energy

Consumer Staples

Consumer Discretionary

% ofprof it

Finance

smaller

Tech

larger

Page 10


32%

35%

38%

41%

44%

47%

50%

53%

56%

59%

62%

65%

68%

Ja

n-4

7

Ja

n-5

0

Ja

n-5

3

Ja

n-5

6

Ja

n-5

9

Ja

n-6

2

Ja

n-6

5

Ja

n-6

8

Ja

n-7

1

Ja

n-7

4

Ja

n-7

7

Ja

n-8

0

Ja

n-8

3

Ja

n-8

6

Ja

n-8

9

Ja

n-9

2

Ja

n-9

5

Ja

n-9

8

Ja

n-0

1

Ja

n-0

4

Ja

n-0

7

Ja

n-1

0

U.S. Commercial Bank Credit as % of U.S. Nominal GDPJan-1947 to present

Post-WW II inflation followed by real growth led to de-

leveraging.

1970s prolonged inflation helped de-leveraging.

Periodic (not linear) deflation (de-leveraging)

shocks

-14%-12%-10%

-8%-6%-4%-2%0%2%4%6%8%

10%12%14%16%

Dec-4

8

Dec-5

0

Dec-5

2

Dec-5

4

Dec-5

6

Dec-5

8

Dec-6

0

Dec-6

2

Dec-6

4

Dec-6

6

Dec-6

8

Dec-7

0

Dec-7

2

Dec-7

4

Dec-7

6

Dec-7

8

Dec-8

0

Dec-8

2

Dec-8

4

Dec-8

6

Dec-8

8

Dec-9

0

Dec-9

2

Dec-9

4

Dec-9

6

Dec-9

8

Dec-0

0

Dec-0

2

Dec-0

4

Dec-0

6

Dec-0

8

Dec-1

0

Total Loans & Leases at Commercial Banks y/y%MINUS Nominal GDP Growth y/y%

i.e, loan growth above/(below) 0% in the chart is above/(below) U.S. nominal output growth

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.

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.

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Fed rate manipulation (10-Y minus FFR): Between ~(1)% inversion and ~3.5% accommodation

10-Year Treasury minus Fed Funds Rate (FFR)

X(win)

X(lose)

Page 11


-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

13%

19

48

19

53

19

58

19

63

19

68

19

73

19

78

19

83

19

88

19

93

19

98

20

03

20

08

20

13

E

When commodities lead, the S&P 500 lags (the

growth stocks mostly)10-yr. Growth Rates

U.S. Commodity Price Growth (%), Left Axis

U.S. Large Cap Stock Market Total Return (Price + Dividend), Right Axis

Commodity equities prosper when pricing power

dependent ROIC(1) is high and cost of capital

(market returns) are low. This “economic profit”

gap appears to us to have peaked, possibly

pressuring commodity stock valuations for years.

Are commodity stocks the other value trade?

With their economic profits possibly peaked they may be a similar short term trade, in our view.

1

10

100

1,000

10,000

1897

1902

1907

1912

1917

1922

1927

1932

1937

1942

1947

1952

1957

1962

1967

1972

1977

1982

1987

1992

1997

2002

2007

2012

No

min

al S

&P

50

0

S&P 500*

Data 1897 to present

1907 to1921

1929 to1949

1968 to1982

2000 toPresent

*S&P Composite before the existence of the S&P 500.

1.00

10.00

100.00

18

97

19

02

19

07

19

12

19

17

19

22

19

27

19

32

19

37

19

42

19

47

19

52

19

57

19

62

19

67

19

72

19

77

19

82

19

87

19

92

19

97

20

02

20

07

20

12

1907-20

Commodity Price Index, Log ScaleData 1897 to present

1932-51

1968-80

1999-2011

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


$500

$600

$700

$800

$900

$1,000

$1,100

$1,200

$1,300

$1,400

$1,500

$1,600

$1,700

$1,800

$1,900

$2,000

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

Inflation-Adjusted S&P 500 Price Index(2)

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

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

Pu

rch

ases a

s a

% o

f T

ota

l, L

TM

Net Purchases of U.S. Securities by ForeignOfficial Institutions & Private Investors

(Sums to 100%)

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.

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.

C

B

A Sold

Equity

Jan-91

Bought

Equity

Apr-01

Selling

Equity

Again A

C

Sold

Equity

Jan-91

Bought

Equity

Apr-01 Selling

Equity

Again B

Page 13


11/1

4/1

929

-09/2

8/1

932

09/2

8/1

932-0

3/0

2/1

933

03/0

2/1

933-0

5/0

9/1

933

05/0

9/1

933

-05/2

8/1

934

05/2

8/1

934-1

2/1

0/1

934

12/1

0/1

934

-05/2

6/1

937

05/2

6/1

937

-09/0

8/1

937

09/0

8/1

937-0

9/1

0/1

937

09/1

0/1

937

-07/2

5/1

938

07/2

5/1

938

-04/0

4/1

939

04/0

4/1

939-0

9/1

4/1

939

09/1

4/1

939

-05/1

4/1

940

05/1

4/1

940

-12/0

3/1

940

12/0

3/1

940

-02/2

6/1

941

02/2

6/1

941

-08/1

2/1

941

08/1

2/1

941

-11/2

1/1

941

11/2

1/1

941

-08/2

0/1

942

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

DJIA: Long Golden Cross/Short Death Cross09/03/1929 to 08/20/1942

04/2

9/1

966-0

2/2

7/1

967

02/2

7/1

967-1

2/1

3/1

967

12/1

3/1

967

-05/2

8/1

968

05/2

8/1

968-0

4/0

2/1

969

04/0

2/1

969

-05/1

9/1

969

05/1

9/1

969-0

6/1

8/1

969

06/1

8/1

969-1

0/0

2/1

970

10/0

2/1

970-0

9/1

4/1

971

09/1

4/1

971

-02/0

7/1

972

02/0

7/1

972-0

4/0

3/1

973

04/0

3/1

973

-11/0

1/1

973

11/0

1/1

973-1

2/0

6/1

973

12/0

6/1

973-0

3/1

2/1

975

03/1

2/1

975-1

0/1

8/1

976

10/1

8/1

976-0

6/0

2/1

978

06/0

2/1

978

-12/0

8/1

978

12/0

8/1

978

-04/1

8/1

979

04/1

8/1

979

-11/1

5/1

979

11/1

5/1

979

-02/0

4/1

980

02/0

4/1

980

-03/3

1/1

980

03/3

1/1

980

-06/2

7/1

980

06/2

7/1

980-0

8/1

0/1

981

08/1

0/1

981-0

9/1

3/1

982

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%DJIA: Long Golden Cross/Short Death Cross

04/28/1966 to 09/13/1982

10/3

0/0

0-0

5/1

4/0

3

05/1

4/0

3-0

8/1

8/0

4

08/1

8/0

4-1

1/0

5/0

4

11/0

5/0

4-0

7/1

9/0

6

07/1

9/0

6-0

9/1

2/0

6

09/1

2/0

6-1

2/2

1/0

7

12/2

1/0

7-0

6/2

3/0

9

06/2

3/0

9-0

7/0

2/1

0

07/0

2/1

0-1

0/2

2/1

0

10/2

2/1

0-0

8/1

1/1

1

08/1

1/1

1-0

1/3

1/1

2

01/3

1/1

2-0

5/2

5/1

2

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

S&P 500: Long Golden Cross/Short Death Cross10/30/00 to present

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.

10

100

1,000

10,000

100,000

1913

1918

1923

1928

1933

1938

1943

1948

1953

1958

1963

1968

1973

1978

1983

1988

1993

1998

2003

2008

Nominal Dow Jones Industrials (green) vs.

Inflation-adjusted (blue, dash), 1913 to 2012YTD

Secular bear market = range-bound, flat periods in nominal terms in which real price levels are under pressure

1929-4213 years

1966-8216 years

2000-

1929-42 secular bear,

momentum fails after 1938

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.

1966-82 secular bear,


2000 to present secular bear,


Page 14


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


44.7%

45.2%

44.4%

43.3%

45.6%

43.6%1Q12

40.5%

41.0%

41.5%

42.0%

42.5%

43.0%

43.5%

44.0%

44.5%

45.0%

45.5%

46.0%

1Q

19

77

2Q

19

78

3Q

19

79

4Q

19

80

1Q

19

82

2Q

19

83

3Q

19

84

4Q

19

85

1Q

19

87

2Q

19

88

3Q

19

89

4Q

19

90

1Q

19

92

2Q

19

93

3Q

19

94

4Q

19

95

1Q

19

97

2Q

19

98

3Q

19

99

4Q

20

00

1Q

20

02

2Q

20

03

3Q

20

04

4Q

20

05

1Q

20

07

2Q

20

08

3Q

20

09

4Q

20

10

1Q

20

12

Consumer Spending on Essentials, % of Personal Income

Red dots mark the start of past recessions

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.

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.

46% recession

start average.

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

1Q

19

77

3Q

19

79

1Q

19

82

3Q

19

84

1Q

19

87

3Q

19

89

1Q

19

92

3Q

19

94

1Q

19

97

3Q

19

99

1Q

20

02

3Q

20

04

1Q

20

07

3Q

20

09

1Q

20

12

Consumer Spending on Essentials, % of Personal Income, by item

Healthcare:

Out of Pocket

Personal

Taxes Paid

Mortgage

Payments

(Principal +

Interest)

Food

Consumed at

Home

Energy:

Personal

Transport &

Utility

Page 16


(DAVIS520)

All Elections ( )

Incumbent Party Wins ( )

Incumbent Party Loses ( )

Plotted Lines Are Average Cycle Patterns

Based on Daily Data From 1900 Through 2008

For Statistics On Election Year Returns, See Study T_10A

All indices equal-weighted and geometric. 94

95

96

97

98

99

100

101

102

103

104

105

106

107

108

109

110

111

94

95

96

97

98

99

100

101

102

103

104

105

106

107

108

109

110

111

Dow Industrials -- Election-Year Cycle (Incumbent Party Wins vs. Loses)

JAN

2012

FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC

Chart has been modified.

Copyright 2012 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved.

. www.ndr.com/vendorinfo/ . For data vendor disclaimers refer to www.ndr.com/copyright.htmlSee NDR Disclaimer at

S&P Low

Used with permission/subscriber.

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.

Incumbent wins if

economy is

stronger.

Incumbent

loses, probably

because

economy is

weaker.

We observe that within

the fiscal discourse

today there appears to

be a conflict between

the “Establishment”

and the “Radicals.” In

the 1960s and early

1970s the

Establishment was

Conservative and the

Radicals bent on

revolution were the

young Liberals. Now,

the Establishment is

Liberal, in our view,

and the Radicals bent

on revolution are the

older Conservatives.

To us that adds an

element of ideological

risk to budget

negotiations (“You say

you want a revolution,

well you know…”) that

could lead to a fiscal

cliff 1/1/2013 that

defies all logic, a risk

we monitor.

Page 17


1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

30 mos.

35 mos.

40 mos.

45 mos.

50 mos.

55 mos.

60 mos.

65 mos.

70 mos.

75 mos.

19

70

Q1

19

72

Q1

19

74

Q1

19

76

Q1

19

78

Q1

19

80

Q1

19

82

Q1

19

84

Q1

19

86

Q1

19

88

Q1

19

90

Q1

19

92

Q1

19

94

Q1

19

96

Q1

19

98

Q1

20

00

Q1

20

02

Q1

20

04

Q1

20

06

Q1

20

08

Q1

20

10

Q1

20

12

Q1

20

14

Q1

20

16

Q1

20

18

Q1

20

20

Q1

Avg. Maturity of Federal Debt Outstanding (Months, Left)

Versus Interest on Federal Debt* as a Percent of GDP (Right)

Avg. Maturity of Total Marketable Federal Debt Outstanding (Lef t Axis)

Federal Gov't 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.

Federal leveraging concurrent with private

de-leveraging is a Keynesian(1) solution made

possible only by reserve currency status(2).

The prior era of

Bond Market

Vigilantes,

1985-1992

The next era of

Bond Market

Vigilantes

Late decade we expect Federal interest to

double to ~4% of GDP, resurrecting the “Bond

Market Vigilantes” to enforce fiscal discipline(3).

U.S. fiscal isn’t a problem until 2015-20, when we see it as the problem.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

130%

1945Q

1

1948Q

1

1951Q

1

1954Q

1

1957Q

1

1960Q

1

1963Q

1

1966Q

1

1969Q

1

1972Q

1

1975Q

1

1978Q

1

1981Q

1

1984Q

1

1987Q

1

1990Q

1

1993Q

1

1996Q

1

1999Q

1

2002Q

1

2005Q

1

2008Q

1

2011Q

1

2014Q

1

2017Q

1

2020Q

1

Debt as a Percentage of U.S. GDP: Federal Debt Held by the Public vs. Household

1945 to 1Q12 Actual, with 2Q12 to 4Q21 Ests.

Federal Debt (Held by the Public) Household Debt

Change in debt since 2Q08 as a % of GDP (bps)Household 2Q08 to 1Q12 change: -1,207 bpsFederal Public 2Q08 to 1Q12 change: +3,281 bps

Page 18


Quarterly Data 3/31/1947 - 3/31/2012

(E300)

Government Spending as a % of GDP

(65.25-Year Average = 19.7% of GDP)

3/31/2012 = 24.0% ( )

Taxes as a % of GDP

(65.25-Year Average = 18.0% of GDP)

3/31/2012 = 17.5% ( )

Data Subject To Revisions By

The Federal Reserve Board Source: All data from Department of Commerce

13

14

15

16

17

18

19

20

21

22

23

24

25

13

14

15

16

17

18

19

20

21

22

23

24

25

Surplus as a % of GDP

Deficit as a % of GDP

3/31/2012 = -6.5%

(65.25-Year Average = -1.6% of GDP) -9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Taxes and Government Spending



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.

Note: In the book “This

Time Is Different, Eight

Centuries of Financial

Folly” by Carmen M.

Reinhart & Kenneth S.

Rogoff, the authors

found that Advanced

Economy real central

government revenue

growth recovers sharply

the third year [e.g., 2011

in the current period]

following major banking

crises per Figure (10.8)

of the book. U.S. tax

revenue began to

recover on schedule as

spending decelerated in

fiscal 2011. This is

timely since real public

debt rises an average

86% in the three years

after a financial crisis

per Figure (10.10) of the

book, which closely

matches the publicly

held U.S. Federal debt

increase of +82.6% the

three years 1Q08

through 1Q11.

X

X

X 22%

2014

18%

2014

4%

2014 (i.e., Not

enough)

4% 4% 4% 4%

Page 19


6x

7x

8x

9x

10x

11x

12x

13x

14x

15x

16x

17x

18x

19x

20x

21x

22x

23x

24x

25x

26x

$600

$700

$800

$900

$1,000

$1,100

$1,200

$1,300

$1,400

$1,500

$1,600

Jan

-08

Ap

r-08

Ju

l-08

Oct-0

8

Jan

-09

Ap

r-09

Ju

l-09

Oct-0

9

Jan

-10

Ap

r-10

Ju

l-10

Oct-1

0

Jan

-11

Ap

r-11

Ju

l-11

Oct-1

1

Jan

-12

Ap

r-12

Ju

l-12

Oct-1

2

Jan

-13

Gold vs. Brent Ratio (Red, Right)vs. S&P 500 (Green, Left)

Shaded Areas are QE1/2 & Operation Twist

S&P 500 Gold/Brent

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.

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).

QE1 QE2 TWIST

QE2 -Jackon

Hole

0.50%

0.75%

1.00%

1.25%

1.50%

1.75%

2.00%

2.25%

2.50%

2.75%

3.00%

8/1

/08

11

/1/0

8

2/1

/09

5/1

/09

8/1

/09

11

/1/0

9

2/1

/10

5/1

/10

8/1

/10

11

/1/1

0

2/1

/11

5/1

/11

8/1

/11

11

/1/1

1

2/1

/12

5/1

/12

8/1

/12

Inflation Expecations: TIPS Breakeven Rates

30YR TIPS Breakeven (LS)

QE1 QE2 TWIST

Gold relative to Brent oil ~16-17x is deflation

(i.e., gold as money(1) is buying more oil),

which historically triggers a Fed response.

30Y Treasury yield TIPS break-even, which

is less manipulated by the Fed, supports

Fed responses at a level of ~2%.

Page 20


3Q08

$0.9T

$1.0T

$1.1T

$1.2T

$1.3T

$1.4T

$1.5T

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

11.5%

12.0%

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

A progressive tax? Personal Interest Income shown

as a % of Total Personal Income (Left)

and dollar amount (Right)

10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

1952Q

1

1955Q

1

1958Q

1

1961Q

1

1964Q

1

1967Q

1

1970Q

1

1973Q

1

1976Q

1

1979Q

1

1982Q

1

1985Q

1

1988Q

1

1991Q

1

1994Q

1

1997Q

1

2000Q

1

2003Q

1

2006Q

1

2009Q

1

2012Q

1

2015Q

1

2018Q

1

2021Q

1

Home Mortgage Debt % of U.S. GDP

Still $2.6 Trillion Higher than 1Q2000

As % GDP

1Q2000 46.4%

of GDP

1Q2012 63.1%

of GDP

63.1% of GDP now- 46.4% of GDP in 1Q00= 16.7% of GDP new debt

x $15.5 trillion GDP 1Q12= $2.6 trillion added debt

1Q2009 75.7%

of GDP

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.

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.

~$500B

per year

Page 21


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.

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%.

-5.0%

-4.5%

-4.0%

-3.5%

-3.0%

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

7.0%

7.5%

8.0%

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

U.S. real GDP y/y percent change (line) is about equal to labor force growth + productivity, or 3% +/- 0.5% real growth 2012-15E

Stifel Nicolaus estimates 2012 to 2015E

U.S. Non-Farm output per hour YY%

Size of the U.S. non-farm labor force Y/Y%

U.S. Real GDP Y/Y%

0.60x

0.65x

0.70x

0.75x

0.80x

0.85x

0.90x

0.95x

1.00x

1.05x

1.10x

1.15x

1.20x

0.00%

0.25%

0.50%

0.75%

1.00%

1.25%

1.50%

1.75%

2.00%

2.25%

2.50%

2.75%

3.00%

3.25%

3.50%

3.75%

4.00%

Ma

r-54

Ma

r-57

Ma

r-60

Ma

r-63

Ma

r-66

Ma

r-69

Ma

r-72

Ma

r-75

Ma

r-78

Ma

r-81

Ma

r-84

Ma

r-87

Ma

r-90

Ma

r-93

Ma

r-96

Ma

r-99

Ma

r-02

Ma

r-05

Ma

r-08

Ma

r-11

Ma

r-14

Ma

r-17

Ma

r-20

Ma

r-23

Ma

r-26

Ma

r-29

Ma

r-32

Ma

r-35

U.S

. ra

tio

35

-49

to

20

-34

ye

ar

old

s,

6-y

r. a

vg

.

Pro

du

cti

vit

y y

/y%

, 6

-yr.

av

g.

U.S. productivity over average peak-to-peak business cycles

(6 years) appears to track the ratio of the middle aged to young workers, supporting 1.5%-2.0% to ~2020, in our view

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)

Page 22


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


90

100

110

120

130

140

150

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Unit Labor Costs in Europe: A gap we see closing by inflating the best

(leaving the U.S. well positioned) and deflating the rest

1Q2000 = 100, Seasonally Adj.

Greece

Portugal

Ireland

France

Italy

Spain

U.S.

Germany

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).

U.S. and Germany

are in-line, but

periphery + France

are un-competitive.

Germany wants peripheral deflation, but we

see unit labor costs(1) converging in both

directions over several years (not quickly).

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.

German central bank credit(2) extended to

peripheral Europe makes Germany both an over-

extended lender and the source of liquidity.

-319

-191

-100

-98

-63

59

120

136

699

-€4

00

-€3

00

-€2

00

-€1

00

€0

€1

00

€2

00

€3

00

€4

00

€5

00

€6

00

€7

00

€8

00

Euro, Billions

Net Claims on other National Central Banks (NCB) via

ECB/TARGET2, May-2012 (2)

Germany is in too deep to trigger insolvencies in the PIGS

Germany

Netherlands

Luxembourg

Finland

Portugal

Greece

Ireland

Italy

Spain

Page 24


30%

32%

34%

36%

38%

40%

42%

44%

46%

48%

50%

52%

54%

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

China: Household Consumptionvs. Gross Capital Formation,

as % GDP, 1980 to 2011

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.”

To ease the transition to consumption

Chinese GDP must preserve cyclical fixed

investment. This may lead to a Chinese fiscal

infrastructure plan in late 2012, in our view.

? Will fixed

investment

plunge before

consumption

can pick up

the slack?

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.

5.00

5.50

6.00

6.50

7.00

7.50

8.00

8.50

9.0065%

66%

67%

68%

69%

70%

71%

72%

73%

74%

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011E

2013E

2015E

2017E

2019E

2021E

2023E

2025E

China's working age population (15-64), % of total (LS)

vs. China Yuan per USD (RS)

Working Age Population (15-64) % of total

China Yuan per USD

China’s worker wave has crested, so now

consumption is needed. China devalued to

accommodate a surge in the working age

population, but that issue crested in 2011.

RMB/$ down,

offset by

Chinese

inflation that

increases the

real effective

exchange

rate.

Page 25


$60

$65

$70

$75

$80

$85

$90

$95

$100

$105

$110

$115

$120

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

$2,200

$2,400

$2,600

$2,800

$3,000

$3,200

$3,400

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

US

Do

llar: M

ajo

r Cu

rren

cie

s In

de

x, N

om

ina

l

Ch

ine

se

Fo

reig

n E

xc

han

ge

Re

serv

es

(Billio

ns

US

D)

Historical US Dollar Major Currencies Index

vs. Chinese FOREX Reserves

Jan-1990 to Jun-2012

Chinese FX Reserves (Left Axis)

US Dollar: Major Currencies Index, Nominal (Right Axis)

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.

China’s reserves and the U.S.$ may again

converge. China facilitated U.S. credit (and

thus dollar weakness) after China’s 2001

WTO entry, but we see that gap closing.

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

30

40

50

60

70

80

90

100

110

120

1936

1941

1946

1951

1956

1961

1966

1971

1976

1981

1986

1991

1996

2001

2006

2011

U.S

. GD

P s

hare

of

glo

bal G

DP

No

min

al t

rad

e-w

eig

hte

d U

.S. $

Nominal Trade-Weighted U.S.$ Major Currency Index, 1936 to 2011 (Left) versus U.S. GDP as a share of global

GDP in Current U.S. $, 1950 to 2011E (Right)

U.S. share of

world GDP and

U.S. dollar

leveling or

bouncing in

2012+, in our

view.

A rising U.S. share of world GDP as the EM

and EU rebalance may lift the dollar. Periods

of U.S. dollar strength typically lift “growth”

stocks and Financials (A, B & C below).

Key to higher U.S. P/E ratios is slowing China and pro-cyclical(1) U.S. dollar strength.

A B

C

Page 26


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


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.

Four years before/five years after average(1) business cycle troughs (current = Jun-09)

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).

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

6.5%

T -

48

T -

36

T -

24

T -

12

T +

0

T +

12

T +

24

T +

36

T +

48

T +

60

Nonfarm Business: Output per Hour of All Persons, S.A.

Troughs = T + 0

Average

Jun-04 to Current

-9.0%

-8.0%

-7.0%

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

T -

48

T -

36

T -

24

T -

12

T +

0

T +

12

T +

24

T +

36

T +

48

T +

60

Nonfarm Business: Avg. Hours Worked of All Persons, S.A.

Troughs = T + 0

Average

Jun-04 to Current

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

T -

48

T -

36

T -

24

T -

12

T +

0

T +

12

T +

24

T +

36

T +

48

T +

60

Private Nonfarm Payrolls, Thsd S.A.Troughs = T + 0

Average

Jun-04 to Current

Productivity

cyclically

peaked for this

cycle…

…and hours

worked

recovered… …so business

must hire to

grow, even if

growth is slow.

Page 28


50

100

150

200

250

Jan-8

8

Jan-9

0

Jan-9

2

Jan-9

4

Jan-9

6

Jan-9

8

Jan-0

0

Jan-0

2

Jan-0

4

Jan-0

6

Jan-0

8

Jan-1

0

Jan-1

2

Home Price Indices vs. Inflation Trend

CS-10 CoreLogic FHFA CPI Trend CS-Natl

Decline to date of 21% for FHFA, 34% for CS-Nat'l, and 37% for CoreLogic indices

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.

Source: S&P/Shiller price index (left), FHLMC Fixed Rate & National Home Price Indices (right).

Likely flat/slightly

down for several

years, in our view.

0. 0%

10. 0%

20. 0%

30. 0%

40. 0%

50. 0%

60. 0%

70. 0%

80. 0%

90. 0%

100. 0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

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

The homeowner's real cost of carry: 30-year mortgage rates minus appreciation (or

depreciation) of U.S. national home prices index (4.1% = long-term average)

Shaded areas indicate NBER U.S. recessions.

5.8% 1Q12

4.1% 1988-2011 avg.

Page 29


$700

$800

$900

$1,000

$1,100

$1,200

$1,300

$1,400

$1,500

$1,600

$1,700

$1,800

$1,900

$2,000

$2,100

$2,200

$2,300

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

Real Residential Construction per Capita

($ 2005/capita)

$1,400

$1,500

$1,600

$1,700

$1,800

$1,900

$2,000

$2,100

$2,200

$2,300

$2,400

$2,500

$2,600

$2,700

$2,800

$2,900

$3,000

19

70

19

72

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

Real Non-Res. Construction per Capita

($ 2005/capita)

Source: U.S. Census, linked indices to account for changes in classification in 1993.

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.

Average

$1,291

per capita

until 1997

Bubble

Post-

Bubble

…and that non-residential adds a

combined $500 per capita faster

than post-bubble residential can do.

Short-

lived

post-

bubble

bounces

Short-

lived

post-

bubble

bounce?

Bubble

S&L failures, Resolution

Trust Company, “Bad

Bank” structures.

Mortgage-

backed

failures,

FNM/FRE

takeover.

Page 30


40,000

50,000

60,000

70,000

80,000

90,000

100,000

110,000

120,000

130,000

140,000

Ja

n-4

8

Ja

n-5

1

Ja

n-5

4

Ja

n-5

7

Ja

n-6

0

Ja

n-6

3

Ja

n-6

6

Ja

n-6

9

Ja

n-7

2

Ja

n-7

5

Ja

n-7

8

Ja

n-8

1

Ja

n-8

4

Ja

n-8

7

Ja

n-9

0

Ja

n-9

3

Ja

n-9

6

Ja

n-9

9

Ja

n-0

2

Ja

n-0

5

Ja

n-0

8

Ja

n-1

1

Ja

n-1

4

U.S. Non-farm Payrolls, Jan-1948 to present, with Stifel

Nicolaus forecast to 2015The picture of a moderate depression

Total Non-farm Payrolls, Thousands

Stifel Projections

7.6%

6.8%

6.0%

5.7%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Ja

n-4

8

Ja

n-5

1

Ja

n-5

4

Ja

n-5

7

Ja

n-6

0

Ja

n-6

3

Ja

n-6

6

Ja

n-6

9

Ja

n-7

2

Ja

n-7

5

Ja

n-7

8

Ja

n-8

1

Ja

n-8

4

Ja

n-8

7

Ja

n-9

0

Ja

n-9

3

Ja

n-9

6

Ja

n-9

9

Ja

n-0

2

Ja

n-0

5

Ja

n-0

8

Ja

n-1

1

Ja

n-1

4

We see the unemployment rate at year-end 2012 7.6%,

with more significant imporvement in 2013-15 eventually reaching the post-W.W. II average of 5.7% by 2015

Source: BEA, U.S. Federal Reserve, Stifel Nicolaus estimates

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).

Page 31


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


https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=3b398377-2c2e-456e-8e74-dcf3368752c0&mime=pdf&co=Stifel&[email protected]&source=libraryView

https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=3b398377-2c2e-456e-8e74-dcf3368752c0&mime=pdf&co=Stifel&[email protected]&source=libraryView

https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=bbc6775e-5938-4222-b632-dbedac69d26d&mime=pdf&co=Stifel&[email protected]&source=libraryView

https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=bbc6775e-5938-4222-b632-dbedac69d26d&mime=pdf&co=Stifel&[email protected]&source=libraryView

https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=c3aea09d-920f-4235-a3ff-892ff941ce55&mime=pdf&co=Stifel&[email protected]&source=libraryView

https://stifel2.bluematrix.com/sellside/EmailDocViewer?encrypt=c3aea09d-920f-4235-a3ff-892ff941ce55&mime=pdf&co=Stifel&[email protected]&source=libraryView

0.1

1.0

10.0

100.01

87

0

18

75

18

80

18

85

18

90

18

95

19

00

19

05

19

10

19

15

19

20

19

25

19

30

19

35

19

40

19

45

19

50

19

55

19

60

19

65

19

70

19

75

19

80

19

85

19

90

19

95

20

00

20

05

20

10

Re

lati

ve

pri

ce

str

en

gth

, s

toc

ks

vs

. c

om

mo

dit

ies

, lo

g s

ca

le

U.S. stock market composite relative to the U.S. commodity market, 1870 to present

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.

U.S. Stock Market relative to the Commodity Market, Annual, 1870 to July 2, 2012 Intra-day.

Post-Civil War Reconstruction ends in

1877, gold standard

begins 1879, deflationary boom,

stocks rally.

WW21939-45

'29 Crash, Gold seized

U.S.$ devalued

in 1933.

Post-WW 1 commodity

bubble bursts,

bull market begins.

WW11914 to

1918

OPEC '73 embargo; 1973-74

Bear Market, Iran fell

'79, Volcker

tightens.

Guns-and-Butter 1960s; Nixon closed

gold window 1971, all

inflationary.

Post-W.W. 2/Korea commodity inflation

bubble bursts, disinflation

ensues, 1950s bull market begins.

OPEC overplays hand and oil prices collapse 1981, Volcker stops inflation

1981-82, Reagan cuts taxes, long Soviet collapse,

disinflation & bull market

1980s-90s.

Credit growth expands money supply relative to commodities, post-

9/11 U.S. $ weakens, Mid-East wars, Asian

commodity use.

Populism in U.S. politics.

Panic of 1907, a

banking crisis & stock market

crash.

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.

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).

Page 33


100

150

200

250

300

350

400

450

500

550

600

650

700

Aug

-98

Feb

-99

Aug

-99

Feb

-00

Aug

-00

Feb

-01

Aug

-01

Feb

-02

Aug

-02

Feb

-03

Aug

-03

Feb

-04

Aug

-04

Feb

-05

Aug

-05

Feb

-06

Aug

-06

Feb

-07

Aug

-07

Feb

-08

Aug

-08

Feb

-09

Aug

-09

Feb

-10

Aug

-10

Feb

-11

Aug

-11

Feb

-12

Commodity Prices (CRB Futures Continuous Commodity Index)(2)

Daily prices 08/14/1998 to present

DIM

INIS

HIN

G R

ET

UR

NS

BO

TT

OM

TO

TO

P

“SECULAR” BULL

MARKET STAGES(1)

Source: Stifel Nicolaus.

(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

the trend fails to over-take the previous high, signaling secular bull market’s end.

Jul-16, 1999 S&P

500 peaks vs. CRB

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.

Dead

cat

bounce

Source: Stifel Nicolaus, CRB Futures from Factset.

(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.

A dead cat

bounce to ~600

that fails to

overtake the April

2011 high?

Page 34


100

150

200

250

300

350

400

450

500

550

600

650

700

Aug

-98

Feb

-99

Aug

-99

Feb

-00

Aug

-00

Feb

-01

Aug

-01

Feb

-02

Aug

-02

Feb

-03

Aug

-03

Feb

-04

Aug

-04

Feb

-05

Aug

-05

Feb

-06

Aug

-06

Feb

-07

Aug

-07

Feb

-08

Aug

-08

Feb

-09

Aug

-09

Feb

-10

Aug

-10

Feb

-11

Aug

-11

Feb

-12

Commodity Prices (CRB Futures Continuous Commodity Index)(2)

Daily prices 08/14/1998 to present

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

$9,000

$10,000

$11,000

$12,000

$13,000

$14,000

$15,000

$16,000

Ja

n-8

1J

an

-82

Ja

n-8

3J

an

-84

Ja

n-8

5J

an

-86

Ja

n-8

7J

an

-88

Ja

n-8

9J

an

-90

Ja

n-9

1J

an

-92

Ja

n-9

3J

an

-94

Ja

n-9

5J

an

-96

Ja

n-9

7J

an

-98

Ja

n-9

9J

an

-00

Ja

n-0

1J

an

-02

Ja

n-0

3J

an

-04

Ja

n-0

5J

an

-06

Ja

n-0

7J

an

-08

Ja

n-0

9J

an

-10

Ja

n-1

1J

an

-12

M3 money + Excess Reserves at the Fed ($ bil.)

Excess Reserves

Institutional Money Funds

Eurodollars

Repos

Large-Time Deposits

Retail Money Funds

Small Denom. Time Deposits

Savings Deposits

Demand & Other Check Deposits

Currency & Travelers Checks

M2 = Below

Sum = M3

M1 = Below

Deng currency reforms in China,

Mexican Peso & Asian debt crises.

33

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.

(2) CRB Continuous Commodity Index, currently an equal-weighted, front-month index of 17 commodities including most high-use energy, metal and agricultural commodities.

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.

+3x

+3x

2008 Change in M3, excl. excess

reserves (not part of M3)

A dead cat

bounce to ~600

that fails to

overtake the April

2011 high?

Page 35


Source: Factset price history, intraday as of July 2, 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.

$0

$50

$100

$150

$200

$250

$300

$350

$400

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

$110

$120

$130

$140

$150

$160

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

PHLX OSX Oil Service Stock Index (Right)

vs. Brent Crude Oil (Left)

$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

$200

$220

$240

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

$110

$120

$130

$140

$150

$160

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

CAT + Deere Stock price (Right)

vs. Brent Crude Oil (Left)

$0

$10

$20

$30

$40

$50

$60

$70

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

$110

$120

$130

$140

$150

$160

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Freeport-McMoRan Copper & Gold

Stock Price (Right) vs. Brent Crude Oil (Left)

Page 36


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.

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).

1.00

10.00

100.00

18

05

18

15

18

25

18

35

18

45

18

55

18

65

18

75

18

85

18

95

19

05

19

15

19

25

19

35

19

45

19

55

19

65

19

75

19

85

19

95

20

05

20

15

E

20

25

E

U.S. Commodity Prices, Annual Averages, Linked Indices

War of 1812 &

Napoleonic Wars (1814

peak)

U.S.Civil War (1864 peak)

World War 1

(1920 peak)

Cold War

(1980 peak)

Commodity Price Index, Log Scale

Data 1805 to July-2012

World War 2,

Korean Conflict

1897 (low)

China stores excess savings as U.S.

dollars, pegs currency - artificially boosts gross fixed capital formation

(commodity intensive)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

19

13

19

20

19

27

19

34

19

41

19

48

19

55

19

62

19

69

19

76

19

83

19

90

19

97

20

04

20

11

U.S. Commodity Price Index, 10-Yr. Average Annual Growth Rate

U.S. M3 Money + Excess Reserves 10-Yr. Average Annual Growth Rate

W.W. 1Colonial Powers

Cold War (1980 peak)

Communism

Socialism (EU, China),

and

Radical (only)

versions of

Theocracy

Commodity Prices (Left Axis) vs. U.S. M3 Money Supply +

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 view1913 Fed creation to 2012YTD shown below

World War 2,Fascism

Page 37


-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

No

v-8

3

Jun-8

4

Jan-8

5

Aug

-85

Mar-

86

Oct-

86

May-8

7

Dec-8

7

Jul-88

Feb

-89

Sep

-89

Ap

r-90

No

v-9

0

Jun-9

1

Jan-9

2

Aug

-92

Mar-

93

Oct-

93

May-9

4

Dec-9

4

Jul-95

Feb

-96

Sep

-96

Ap

r-97

No

v-9

7

Jun-9

8

Jan-9

9

Aug

-99

Mar-

00

Oct-

00

May-0

1

Dec-0

1

Jul-02

Feb

-03

Sep

-03

Ap

r-04

No

v-0

4

Jun-0

5

Jan-0

6

Aug

-06

Mar-

07

Oct-

07

May-0

8

Dec-0

8

Jul-09

Feb

-10

Sep

-10

Ap

r-11

No

v-1

1

U.S. Bond Market Aggregate Return minusU.S. Nominal GDP y/y%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

No

v-8

3

Jun-8

4

Jan-8

5

Aug

-85

Mar-

86

Oct-

86

May-8

7

Dec-8

7

Jul-88

Feb

-89

Sep

-89

Ap

r-90

No

v-9

0

Jun-9

1

Jan-9

2

Aug

-92

Mar-

93

Oct-

93

May-9

4

Dec-9

4

Jul-95

Feb

-96

Sep

-96

Ap

r-97

No

v-9

7

Jun-9

8

Jan-9

9

Aug

-99

Mar-

00

Oct-

00

May-0

1

Dec-0

1

Jul-02

Feb

-03

Sep

-03

Ap

r-04

No

v-0

4

Jun-0

5

Jan-0

6

Aug

-06

Mar-

07

Oct-

07

May-0

8

Dec-0

8

Jul-09

Feb

-10

Sep

-10

Ap

r-11

No

v-1

1

S&P 500 Total Return minusU.S. Nominal GDP y/y%

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

No

v-8

3

Jun-8

4

Jan-8

5

Aug

-85

Mar-

86

Oct-

86

May-8

7

Dec-8

7

Jul-88

Feb

-89

Sep

-89

Ap

r-90

No

v-9

0

Jun-9

1

Jan-9

2

Aug

-92

Mar-

93

Oct-

93

May-9

4

Dec-9

4

Jul-95

Feb

-96

Sep

-96

Ap

r-97

No

v-9

7

Jun-9

8

Jan-9

9

Aug

-99

Mar-

00

Oct-

00

May-0

1

Dec-0

1

Jul-02

Feb

-03

Sep

-03

Ap

r-04

No

v-0

4

Jun-0

5

Jan-0

6

Aug

-06

Mar-

07

Oct-

07

May-0

8

Dec-0

8

Jul-09

Feb

-10

Sep

-10

Ap

r-11

No

v-1

1

FHFA U.S. House Price Index minusU.S. Nominal GDP y/y%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

No

v-8

3

Jun-8

4

Jan-8

5

Aug

-85

Mar-

86

Oct-

86

May-8

7

Dec-8

7

Jul-88

Feb

-89

Sep

-89

Ap

r-90

No

v-9

0

Jun-9

1

Jan-9

2

Aug

-92

Mar-

93

Oct-

93

May-9

4

Dec-9

4

Jul-95

Feb

-96

Sep

-96

Ap

r-97

No

v-9

7

Jun-9

8

Jan-9

9

Aug

-99

Mar-

00

Oct-

00

May-0

1

Dec-0

1

Jul-02

Feb

-03

Sep

-03

Ap

r-04

No

v-0

4

Jun-0

5

Jan-0

6

Aug

-06

Mar-

07

Oct-

07

May-0

8

Dec-0

8

Jul-09

Feb

-10

Sep

-10

Ap

r-11

No

v-1

1

CRB Futures Commodities Price Index minusU.S. Nominal GDP y/y%

Fed QEplus

China stimulus

"extension"

We think commodities are vulnerable to

either deflation or modest reflation(1), the

two most likely outcomes we see. During

a period in which money rates fell to 0%

(chart below), caused by leverage

creating and thus debasing money, the

excess return above GDP (right charts) of

assets progressed from high quality

income instruments (bonds, stocks) to

low income producing assets (houses)

and finally to zero income commodities.

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

10Y Treasury vs. Federal Funds Credit debased money by increasing its quantity, leading to lower

rates (money had less worth and thus a lower price) that, in turn, lowered the bar on income producing assets to include non-

income producing commodities.

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


Source: Federal Reserve, FactSet. Charts formats and annotations Stifel Nicolaus & Co.

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.

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

11%

12%

13%

14%

15%

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

10-Year Treasury Yield Fed Funds Rate

The Fed forced the Fed Funds Rate (FFR) to "lower lows" to achieve a positive spread between the 10Y yield and FFR

-100%

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

220%

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

Fed Funds Rate y/y% chg. 10-Year Treasury Yield y/y% chg.

Eventually hiking the FFR from ~7bps to ~75bps would be upwards of a 1,000% change in the FFR, a harbinger of crisis for whose who rely on low cost money, such as

commodities in the present era

(A) 6/84 peak, Continental Bank fails(B) 3/89 peak, Drexel Burnham, S&Ls fail(C) 12/94 peak, Mexico, Asia/EM debt crisis(D) 6/00 peak, S&P & NASDAQ melt-down(E) 5/05 peak, housing peaks the next year(F) 10/10 peak, EU debt crisis, China slows

(B)

(C)

(D)

(E)

(F)

(A)

Page 39


$0

$5

$10

$15

$20

$25

$30

0%

2%

4%

6%

8%

10%

12%

14%

16%

T-1

0

T-8

T-6

T-4

T-2

T+

0

T+

2

T+

4

T+

6

T+

8

T+

10

T+

12

T+

14

T+

16

T+

18

T+

20

Real GDP Growth per Annum (Blue, LS) vs.GDP per capita in U.S. $ (Red, RS)

3-Country Avg:Japan 1964-1994

S. Korea 1980-2010Taiwan 1978-2008

Real GDP y/y % (LS)

US $Thous.

% ofGDP

China: Y/Y Real GDP Growth (%)

2001-2011 3-Country Avg:Japan 1964-1994

S. Korea 1980-2010Taiwan 1978-2008

Real GDP per capita (RS)

China: GDP/Capita

tracking normal

-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

14.00%

16.00%

18.00%

20.00%

22.00%

24.00%

T-1

0

T-8

T-6

T-4

T-2

T+

0

T+

2

T+

4

T+

6

T+

8

T+

10

T+

12

T+

14

T+

16

T+

18

T+

20

An

nu

ali

zed

Gro

wth

: O

il C

on

su

mp

tio

n p

er

Cap

ita

3 Country's Average Barrels of Oil Equivalent (Oil + Natural Gas) Consumption per Capita, Y/Y Growth

Rate* vs. China 2001-Present

China (2002-2011)

Japan (1964-1994)

Taiwan (1978-2008)

Korea (1980-2010)

*Shown smoothed

Source: BP Annual Review, IEA, UN, Japanese Ministry of Internal Affairs and Communications, OECD, IMF.

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.

(1) Gross National Savings is the sum of the government surplus/(deficit) plus personal savings and corporate savings (retained earnings).

Page 40


15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

55,000

19

70

19

73

19

76

19

79

19

82

19

85

19

88

19

91

19

94

19

97

20

00

20

03

20

06

20

09

G7 (U.S., U.K., Ger, Fr, It, Jap, Can)Oil Demand, 1970-2011 (000s bbl.)

37% of world oil demand growingat an average 0.0% y/y growth rate

bbl. 000s/day

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

55,000

60,000

19

70

19

73

19

76

19

79

19

82

19

85

19

88

19

91

19

94

19

97

20

00

20

03

20

06

20

09

Non-G7 Country Oil Demand, 1970-2011 (000s bbl.)

63% of world oil demand growingat an average 2.9% growth rate

bbl. 000s/day

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.

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.

To flatten

2012-15E,

in our view

Page 41


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


-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

22.0%

1835

1840

1845

1850

1855

1860

1865

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

S&P Stock Market Composite Trailing 10-Year Compound Annual Total Return (Includes Reinvested Dividends) ,

Data 1825 to December, 2011

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.

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.”

12/31/98

S&P 500

1,229.23

Only 16 of the past 176 years had a lower 10-year rolling return than today.

12/31/11

S&P 500

1,257.60

Page 43


-7.0%

-5.0%

-3.0%

-1.0%

1.0%

3.0%

5.0%

7.0%

9.0%

11.0%

13.0%

15.0%

17.0%

19.0%

21.0%

23.0%0x

5x

10x

15x

20x

25x

30x

35x

40x

45x 1937

1942

1947

1952

1957

1962

1967

1972

1977

1982

1987

1992

1997

2002

2007

2012

2017

2022

S&

P 5

00 1

0-y

ear

tota

l re

turn

, an

nu

alized

Cyclically A

dju

ste

d P

/E R

ati

o, in

vert

ed

axis

Cyclically Adjusted P/E* Ratio for the S&P 500, moved ahead 10 years (Left, inverted) vs. Trailing 10-year S&P 500 total (price + dividend) return (right, normal scale),

1937 to 2022E

CAPE Ratio for S&P 500, moved ahead 10 years, left scale

S&P 500 10-year trailing annualized total (price + dividend) return, right scale

* 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 = 0.6899CAPE 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

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.

Expected

S&P 500

trailing 10-

year return

in 2022E =

7% to 9%:

2.25% Yield

4.75% EPS

0-2% P/E*

7% to 9%

* If P/E rises to

16x by 2022

that is 2%/yr.

from P/E, if flat

at 13.5x 2012

to 2022 that is

0% from P/E.

Page 44


Monthly Data 12/31/1924 - 6/30/2012 (Log Scale)

(S702)

8/31/1929 = 86.6%

11/30/1936 = 71.6% 12/31/1965 = 71.9%

11/30/1968 = 76.5%

1/31/1973 = 79.4%

7/31/1982 = 32.2%

10/31/1990 = 43.3%

3/31/2000 = 172.6%

6/30/1932 = 26.6%

4/30/1942 = 19.4%

9/30/1974 = 36.3%

Very Undervalued

Very Overvalued

Norm Since 1925 = 61.0%

NDR Estimated value of 3900 U.S. common stocks: $15. 62 trillion

U.S. Nominal Gross Domestic Product (latest figure): $15. 47 trillion

Current ratio for 6/30/2012 (solid line): 101. 0 %

Value of S&P 500 Index constituents: $12. 30 trillion

U.S. Nominal Gross Domestic Product (latest figure): $15. 47 trillion

Current ratio for 6/30/2012 (dashed line): 79. 5 %

Linear regression trendline value:

(Heavy Dashed Line)

6/30/2012 = 90.5%

NDR Estimated Fixed-Weighted GDP December 1924 - February 1946

Chain-Weighted GDP used after February 1946

Calculation uses NDR Estimated Common Stock Market Capitalization of U.S.-based Companies

Dow Jones Total Stock Market Capitalization used from January 1973 through September 1980

NYSE Market Capitalization used prior to January 1973

Concept Courtesy: Jim Bianco

Source: Ned Davis Research, Inc.

20

22

24

26

29

32

35

38

42

46

51

56

61

67

74

81

89

98

107

118

129

142

156

172

20

22

24

26

29

32

35

38

42

46

51

56

61

67

74

81

89

98

107

118

129

142

156

172

19

25

19

30

19

35

19

40

19

45

19

50

19

55

19

60

19

65

19

70

19

75

19

80

19

85

19

90

19

95

20

00

20

05

20

10

Stock Market Capitalization as a Percentage of Nominal GDP



A

B

Used with permission/subscriber.

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.

(Red Line)

(Blue Line)

Page 45


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.

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

30

32

34

36

38

40

42

44

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

2012

Dow to Gold RatioThree stage bearmarket completed

The Dow vs. Gold has been a classic Shock, Acceptance & Capitulation movement.

Is gold's leadership over?

Shock & Disbelief

Acceptance

Capitulation

NASDAQ and U.S. growth stock bubble

peaks.

This is the Dow Jones 30 Industrials divided by the price

of Gold per ounce, monthly since 1982.

Source: Dow Jones data via Bloomberg and FactSet, Stifel Nicolaus format.

Page 46


-10.0%-9.0%-8.0%-7.0%-6.0%-5.0%-4.0%-3.0%-2.0%-1.0%0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%9.0%

10.0%11.0%12.0%13.0%14.0%15.0%16.0%17.0%18.0%19.0%20.0%

18

05

18

15

18

25

18

35

18

45

18

55

18

65

18

75

18

85

18

95

19

05

19

15

19

25

19

35

19

45

19

55

19

65

19

75

19

85

19

95

20

05

20

15

E

20

25

E

20

35

E

Commodity price inflation follows a Kondratiev CycleK-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.

1814 peakWar of 1812/

Napoleonic Wars

1864 peakU.S. Civil

War

50 years

2035peak?

1920 peakJust after

W.W.I

1980 peakCold War

56 years

60 years

55 years

54 years52 years

61 years56 years

1824 1878

1930

1991

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.

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.

Est.

path

2012-

2035

2047

bottom?

Page 47


Important Disclosures and Certifications

I, 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 Disclosures

Please 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


http://www.stifel.com?

http://www.stifel.com?

The 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 byS&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


Economy & Finance

Market strategy