War Room 11 Oct 2011 The Recession Strikes Back

War Room Monthly macro discussion Using tools in context Feature for subscribers only Feedback - what should it to be?

The Recession Strikes Back Europe Recap US exposure to Europe USA Macro Snapshot Why does it feel so bad?

Europe – where are we right now? 2008 – toxic debts on bank balance sheets – toxic debts now on public balance sheets. Europe’s two big problems: 1.Recapitalization of EU Banks 2.Credible plan to preserve the stability sovereign debt of Spain + Italy Don’t get caught up in the noise: Slovakia Vote Politician PR Efforts Oversold rallies Protests LET THE DATA GUIDE YOU

PIIGS debt (as % of GDP): Greece more than double Argie + Russia at default Source: World Economic Outlook, April 2011, International Monetary Fund Argentina default: 65% Argentina default: 65% Russia default: 57% Russia default: 57%

Preparing for Greek Default Euro Crisis Averted  Now impossible scenario Greek Bailout package: JulySoft Restructuring – lower rates + extend maturity 21% discount in bond restructuring established OctHard Restructuring – principal reduction 50-60% discount now needed Sources: Jean-Claude Juncker, Euro Group President Standard + Poors Ottmar Essing, former ECB Chief Economist Thomas Straubhaar, Director of World Economic Institute Greek Default guaranteed 1. Euro Zone Dismissal? 2. Can fallout be contained?

Currencies + Markets = basics Dollar + Euro – inverse correlation Dollar + S/P 500 – inverse correlation

US Economy: exposure to Europe EU – double dip recession begun Markit Eurozone Purchasing Managers Index: 50.4 (Contraction is anything below 50)

US Banks: exposure to EU defaults + EU bank counterparties Tim Geithner, U.S. Treasury Secretary “The direct exposure of the US financial system to the countries under the most pressure in Europe is very modest… very limited” Congressional Research Service 641 billion usd US Banks exposure to PIIGS 1.2 trillion usd US Banks exposure to German + French Banks holdings – loans, derivative contracts, guarantees, credit commitments Geithner is wrong!!

US + EU Contagion Euro Banks - Three banks nationalized in the last week - Dexia = 5.4 billion euros in exposure to Greek Debt 2008 Contagion as guide - Counterparty risk coming to fruition eliminates hedges - US govt kept AIG artificially alive to pay out other banks - Equity markets took SIX weeks to bottom post-Lehman Historical Austrian bank Credit Anstalt led to contagion in US period saw bank runs in Europe + US 2011 downside potential worse than 2008

Consequences: 1.Credit Crunch in lending to Italy + Spain 2.Other PIIGS decide to leave the Euro 3.EU deep recession 4.Contagion spreads to US banks Can Greek Fallout Be Contained? Consequences: 1.Greece likely exits Euro 2.Drachmas already trading on “when issued” basis 3.No carte blanche for other PIIGS 4.Recapitalization plan works

US ECONOMY – OCTOBER SNAPSHOT The Recession Strikes Back

The VIX experienced its second highest spike ever in early August, indicating the extent to which fear has taken over the market. While much of the rise in retail sales since 2009 can be explained by inflation, sales have held up this year and are still growing at 3% net of inflation. Why does it still feel like a recession? From a jobs perspective, we're still at a level of jobless claims consistent with the previous two US recessions (early 90's and early 2000's).

US Indicators: ISM, Oil, and BDI ISM Indexes both holding over 50 for now Dry shipping rates up, oil down: Two positive trends

Total Employment Down, Down, Down Total US employment peaked at 138 million in 2007, and is still 6 million below that level, even as the US population has grown by 8 million.

Employment Ratio: Down, Down, Down No comparable drop in employment ratio has occurred since the Great Depression.

US GDP and Productivity in Context Productivity rises tend to accompany layoffs – in this context, low current productivity growth isn't all bad. When GDP growth drops below the red line (population growth), it feels like a recession.