Is There an Economic Downturn in the Near-Term Future – a Capital Markets’ Perspective? John Lonski, MD-Chief Capital Mkt Economist, Capital Markets Research Group September 2018

Emerging Markets Have Difficulty Coping with a Stronger Dollar 1 Emerging Markets Have Difficulty Coping with a Stronger Dollar

Market Value of US Common Stock Soars as Chinese Equities Struggle … Shanghai Composite Peaked in June 2015 source: Moody's Analytics

Cheaper Industrial Commodities and Stronger Dollar Are Anathema for Heavily Indebted Emerging Market Countries source: Federal Reserve, Moody’s Analytics

Industrial Metals Price Index's Latest Dive Weighs Against an Impending and Extended Stay by 10-Year Treasury Yield Above 3% source: Moody's Analytics

2 US Economy May Still Have Room to Grow without Triggering a Disruptive Climb by Price Inflation

Never Before Has a 3.9% Jobless Rate Been Joined By Such a High Percentage of Manufacturing Capacity Not In Use source: BLS, Federal Reserve, Moody's Analytics ... Latest Capacity-Not-In-Use Has Been Associated with a 5.3% Average for Jobless Rate

Never Before Has a 3.9% Jobless Rate Been Joined By Such a Slow Rate of Wage & Salary Income Growth source: BLS, BEA, Moody's Analytics When the UR last dipped to 3.9% in Q2-2000, W&S income grew by 7.6% annually during year-ended June 2000, which was much faster than its 4.8% increase of the year-ended June 2018.

Current High Percentage of 25 to 54 Year Age Cohort Not In Labor Force Typically Favors a 6.4% Midpoint for Jobless Rate vs Actual 3.9% moving 3-month averages; source: BLS, Moody's Analytics When the UR last dipped to 3.9% in Q2-2000, W&S income grew by 7.6% annually during year-ended June 2000, which was much faster than its 4.8% increase of the year-ended June 2018.

Recession May Be Near When Unemployment Rate's Moving Three-Month Average Turns Higher Amid a Mature Economic Recovery source: BLS, BEA, Moody’s Analytics The unemployment rate’s moving three-month average has been less than 4% in only 5% of all the months since the end of 1967. The jobless rate’s moving three month average bottomed at the 3.4% of October 1968 through June 1969. A very low unemployment rate should breed caution regarding the longevity of the current business cycle upturn.

Within 3 Years After the Last 3 Recessions, Fed Funds Sank by -485 bp and 10-Year Treasury Yield Fell by -245 bp, On Average actual & predicted values; source: Federal Reserve, Blue Chip Economic Indicators, Moody’s Analytics

3 US Treasury Bond Yields Fail to Lift-Off Despite Fast Rising Ratio of US Government Debt to GDP

Mandatory Spending Requirements (Social Security & Medicare) Stemming from Aging "Baby Boomers" Is Expected to Drive US Treasury Debt Up to 90% of GDP by 2027 source: CBO, Bloomberg, Moody’s Analytics

Historically Slow Growth of US' Total Private and Public Nonfinancial Sector Debt Reins In 10-year Treasury Yield yearlong averages; source: Federal Reserve, Moody’s Analytics

Elevated Ratio of Private & Public Nonfinancial-Sector Debt to GDP Reins In Treasury Bond Yields yearlong averages; source: Federal Reserve, BEA, Moody's Analytics

Blue Chip Survey Assigns a Range of 2. 9% to 3 Blue Chip Survey Assigns a Range of 2.9% to 3.25% for Average 10-Year Treasury Yield of 2018's Second Half

Ten-year Government Bond Yields Recent Yields of 0. 38% for Germany, 0 Ten-year Government Bond Yields Recent Yields of 0.38% for Germany, 0.10% for Japan and 1.31% for the UK Rein In US Treasury Yield in %; source: Bloomberg, Moody's Analytics

4 Interest-Rate-Sensitive Home Sales Sag Under the Weight of Higher Treasury Bond Yields

Fewer Unit Home Sales Rein In Treasury Bond Yields source: National Association of Realtors, US Census Bureau, Moody's Analytics THS average pace of three months ended July 2018 trails cycle peak of Q4-2017 by -3.7%. Index of PHS for 3-months-ended Jul-18 was down by -2.4% yy and contracted by -2.8% annualized from contiguous 3-months-ended April 2018. 30-year mortgage yield averaged 4.56% during 3-months-ended July 2018 – up 60 bp yy & up 15 bp from average of 3-months-ended April 2018.

5 Default Rate’s Declining Trend Defies Record Ratio of Corporate Debt to GDP

High-Yield Default Rate Is Expected to Drop from July 2018’s 3.4% to 2.4% by 2019’s First Quarter source: Moody's Investors Service, Moody’s Analytics Back in April 2018, Moody’s Default Research Group predicted that the US’ high-yield default rate would fall from the 3.65% of 2018’s first quarter to 1.9% by 2019’s first quarter. Since then, the Default Research Group has a less benign view of defaults and now expects the default rate to slide from the 3.7% of 2018’s second quarter (including June’s 3.4%) to 2.5% by 2019’s first quarter. Trade-related uncertainties, the softening of important foreign economies, and the FOMC’s upwardly revised outlook for fed funds despite slippage abroad, lower industrial metals prices, and lower home sales in US are consistent with the upward revision of early 2019’s expected default rate. The recent sideways movement by the high-yield bond spread favors a 3.0% midpoint for October 2018’s default rate, which practically matches the 3.1% predicted by the Default research Group. A default rate forecasting model employing the high-yield bond spread of three months back generates a very strong adjusted R-square statistic of 0.91. the high-yield spread’s default forecasting ability deteriorates noticeably moving beyond three months.

Default Rate Last Sank Amid a Fast Rising Ratio of Corporate Debt to GDP during the Late 1980s source: Moody's Investors Service, BEA, Moody's Analytics

Ratio of Corporate Debt to Profits Looks Far Less Alarming than the Ratio of Debt to GDP source: Moody's Investors Service, BEA, Moody's Analytics 892.6% 927.4% 730.8% Recent 731% ratio of corporate debt to profits from current production is less than its 893% median when the ratio of corporate debt to GDP was between 44% and 45%.

Rising Trend for Profits Offsets the Loss of Credit Quality to a Steep Ratio of Corporate Debt to GDP in Late-1980s and Today US nonfinancial corporations; source: BEA, Moody's Analytics

Each Deeper Than -5% Drop by Profits from then Record High Was Joined by a High-Yield Default Rate in Excess of 5% source: Moody's Investors Service, BEA, Moody’s Analytics Back in April 2018, Moody’s Default Research Group predicted that the US’ high-yield default rate would fall from the 3.65% of 2018’s first quarter to 1.9% by 2019’s first quarter. Since then, the Default Research Group has a less benign view of defaults and now expects the default rate to slide from the 3.7% of 2018’s second quarter (including June’s 3.4%) to 2.5% by 2019’s first quarter. Trade-related uncertainties, the softening of important foreign economies, and the FOMC’s upwardly revised outlook for fed funds despite slippage abroad, lower industrial metals prices, and lower home sales in US are consistent with the upward revision of early 2019’s expected default rate. The recent sideways movement by the high-yield bond spread favors a 3.0% midpoint for October 2018’s default rate, which practically matches the 3.1% predicted by the Default research Group. A default rate forecasting model employing the high-yield bond spread of three months back generates a very strong adjusted R-square statistic of 0.91. the high-yield spread’s default forecasting ability deteriorates noticeably moving beyond three months.

Benign Default Outlook Assumes Coverage of Net Interest Expense Does Not Worsen US nonfinancial companies; source: BEA, Moody’s Investors Service, Moody's Analytics

6 Richly-Priced US Equities Find Support from Profits Growth, Tolerable Interest Rates, and Declining Default Rate

Highest Aggregate Price:Earnings Ratio since Q1-2002 Gets Support from Very Low Corporate Bond Yields source: BEA, Moody's Analytics

Since 1992, 90% of the 174 Year-to-Year Declines by the Monthly Default Rate Were Joined by a Year-to-Year Increase for the Market Value of Common Stock

Recent VIX Favors a 380 basis points High-Yield Spread … Medians Are 16.0 Points for VIX and 460 bp for High-Yield Spread source: CBOE, Moody's Analytics

7 Electric and Gas Utilities Help to Contain Consumer Price Inflation amid a Very Low unemployment Rate

Annual Rates of Consumer Price Growth for 3-Months-Ended Jul-18 Are 2 Annual Rates of Consumer Price Growth for 3-Months-Ended Jul-18 Are 2.3% for Core CPI, 0.0% for Electricity and -1.4% for Natural Gas source: BLS, Moody's Analytics 5.39206E-05 -0.014018807 0.022821305

Capacity Utilization Rate Trends Lower After Averaging 93 Capacity Utilization Rate Trends Lower After Averaging 93.2% during 1998-2000 … Was at 78.0% in July 2018 source: Federal Reserve, Moody's Analytics 104.9747 -0.7% 3.7% 104.4697 -0.5% 2.3% Despite hot summer and a sizzling economy, seasonally-adjusted electric & gas utility production fell in each of the three-months-ended July. July’s electric & gas utility output rose by a modest 2.3% from a year earlier. July’s electric power generation, transmission & distribution dipped by -0.9% from June and edged up by 1.4% from July 2017. July’s total IP was up by 4.2% yy, wherein manufacturing output increased by 2.8% and natural resource output advanced by 12.9.

© 2014 Moody’s Analytics, Inc © 2014 Moody’s Analytics, Inc. and/or its licensors and affiliates (collectively, “MOODY’S”). All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. Under no circumstances shall MOODY’S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY’S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY’S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding, or selling.