1. John E. Silvia, Chief Economist February 2, 2016 The Great Divide: Opportunity in Differences The Risk Management Association

2. RMA 2 Where Are We Now? Source: Five benchmarks for good decision making Inflation Interest Rates Growth Profits The Dollar

3. RMA 3 Expectations for the Future Wells Fargo vs. Consensus How do we differ from consensus?  Sustained-trend growth, no recession in 2016  Employment—cyclical and structural change  Consumer solid  Housing improving—multifamily especially  State and local governments—revenues up  Unsustainable long-run fiscal policy  Europe improvement ahead  China growth sub 6.5 percent for 2016, 2017

4. RMA 4 Sustained Growth in 2015—Great Divide Between Domestic and Trade Following a poor start to 2015, GDP growth has improved. Trend growth prospects in the year ahead. Consumer and housing lead but exports a drag Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

5. RMA 5 Manufacturing & Services: A Divide Indexes on business activity suggest continued growth for 2015 and 2016, services have been a bulwark—manufacturing impacted by dollar and lower energy prices—industrial recession (Barron’s 11/14/2015) Source: Institute for Supply Management and Wells Fargo Securities, LLC

6. RMA 6 Wages & Salaries Wages & salaries are best associated with consumer spending—not wages alone Source: U.S. Department of Labor, U.S. Department of Commerce and Wells Fargo Securities, LLC

7. RMA 7 Wage Fundamentals Inflation and productivity are two of the major drivers of wages Source: U.S. Department of Labor, U.S. Department of Commerce and Wells Fargo Securities, LLC

8. RMA 8 Household Debt Delinquencies: Student Loans the Exception Tighter credit standards and a strengthening economy have helped to improve the credit position of households over the past 3 years—excluding student debt. Source: FRBNY and Wells Fargo Securities, LLC

9. RMA 9 Housing: More Multifamily We continue to look for a gradual recovery in homebuilding. Apartment demand remains exceptionally strong but supply is catching up with demand. Single-family housing starts are beginning to ramp back up. Gains will be more modest than in past building cycles. Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

10. RMA 10 Tech Sector / Energy Sector Comparison The tech sector in the late 1990s comprised a 4X larger share of employment and was more than a third of the market cap of the S&P 500. Energy in the summer of 2014 was only about 10% of the market cap. Market Cap Employment Source: U.S. Dept. of Commerce, Bureau of Labor Statistics, (Energy Industries include: petroleum and coal products, support activities for mining, pipeline transportation), Standard and Poor’s and Wells Fargo Securities, LLC

11. RMA 11 Business Fixed Investment Capex in the tech sector comprises a 22% share of all business investment spending. Investment in the energy sector (while a key driver of growth from 2009-2012) still comprised less than 6% of all business outlays. Source: U.S. Department of Commerce, and Wells Fargo Securities, LLC Energy Spending Tech Spending

12. RMA 12 Business Spending: Flat Tough to find reasons to get excited about prospects for capital outlays. Factory orders have risen at a 1 percent annual rate over last three months and only 0.4 percent over the past year Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

13. RMA 13 Inflation & Interest Rates Inflation Interest Rates Growth Profits The Dollar Core Inflation Interest Rates Yield Curve The Dollar Wage-Price Spiral Market Expectations Key Drivers

14. RMA 14 Inflation: Rising—But Less Than Market/FOMC Expect Inflation remains historically low, but we expect to see a pickup in coming quarters – average less than 2% since 1991 Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

15. RMA 15 Inflation: A Divide in Goods vs. Services Inflation for services has been much firmer than for commodities—Macy’s backstage stores (WSJ 11/12/15) Source: U.S. Department of Labor and Wells Fargo Securities, LLC

16. RMA 16 FOMC Projections Core PCE inflation projections have come down recently Source: Federal Reserve Board and Wells Fargo Securities, LLC

17. RMA 17 Pace of Policy Firming: Not Four Increases in 2016 The FOMC hiked rates in December. The long-term funds rate projection curiously held steady Source: Federal Reserve Board, Bloomberg LP and Wells Fargo Securities, LLC

18. RMA 18 Foreign Exchange Fundamentals The interest rate differential is a key driver of currency moves Source: Bloomberg LP and Wells Fargo Securities, LLC

19. RMA 19 Corporate Leverage Better overall for manufacturing firms but interest coverage ratios in the mining sectors have decreased markedly Source: U.S. Department of Commerce and Wells Fargo Securities, LLC

20. RMA 20 It Happens Every Cycle… “Underwriting standards eased at a significant number of banks for the three-year period from 2013 through 2015. This trend reflects broad trends similar to those experienced from 2005 through 2007…” Source: OCC and Wells Fargo Securities, LLC

21. RMA 21 Corporate Profits Fundamentals Real GDP growth is in the 2.0-2.5 percent range, but corporate profits are weakening If GDP growth is expected to pick up, why not profits? Short answer: Firms’ labor costs are rising as well Source: U.S. Department of Commerce, Federal Reserve Board and Wells Fargo Securities, LLC

22. RMA 22 Labor Costs Labor costs have begun to rise (marginally) Although nominal GDP growth likely will remain above the growth rate of unit labor costs in 2016, the growth rates should converge Rising labor costs + tightening financial conditions = weak profit growth Source: U.S. Department of Commerce, Federal Reserve Board and Wells Fargo Securities, LLC

23. RMA 23 Increased Financing Needs Leverage is down owing largely to post-recession rebound in stock prices. Capex is consistently outpacing internally generated funds for the first time since the recession Source: Federal Reserve Board, U.S. Department of Commerce and Wells Fargo Securities, LLC Corporate Financing NeedsCorporate Leverage 23

24. RMA 24 Financial Conditions Rising spreads mean corporate financing faces a headwind rather than a tailwind. So far we expect only modest increases in long-term interest rates. Market assessment of rising credit risk is evident in increasing credit and CDS spreads Source: FactSet, Bloomberg LP and Wells Fargo Securities, LLC CDS SpreadsCredit Spreads 24

25. RMA 25 Interest Expense Net interest expense as a share of operating surplus of nonfinancial corporates typically rises late in the cycle as rising labor costs squeeze profits and yield spreads rise Source: Federal Reserve Board and Wells Fargo Securities, LLC

26. RMA 26 Cracks In Bank Lending Market? The noncurrent loan rate for commercial & industrial loans has increased for three consecutive quarters. It is tempting to blame energy, but the regional data show a different story, as jumps are apparent across all regions (bigger in energy country) Source: FDIC and Wells Fargo Securities, LLC Noncurrent Loan Rates by RegionNoncurrent Loan Rates 26

27. RMA 27 U.S. Forecast Source: U.S. Department of Commerce, U.S. Department of Labor, Federal Reserve Board, Freddie Mac and Wells Fargo Securities, LLC

28. Appendix

29. RMA 29 Recent Special Commentary Wells Fargo Economics Group Publications To join any of our research distribution lists please visit our website: http://www.wellsfargo.com/ economics

30. RMA Wells Fargo Securities, LLC Economics Group 30 John E. Silvia …....................... … john.silvia@wellsfargo.comjohn.silvia@wellsfargo.com Global Head of Research and Economics Diane Schumaker-Krieg ………………… …… ….diane.schumaker@wellsfargo.comdiane.schumaker@wellsfargo.com Global Head of Research & Economics Chief Economist Mark Vitner, Senior Economist……………....……….. mark.vitner@wellsfargo.commark.vitner@wellsfargo.com Jay H. Bryson, Global Economist …………………....…… …. jay.bryson@wellsfargo.com jay.bryson@wellsfargo.com Sam Bullard, Senior Economistsam.bullard@wellsfargo.comsam.bullard@wellsfargo.com Nick Bennenbroek, Currency Strategist……nicholas.bennenbroek@wellsfargo.comnicholas.bennenbroek@wellsfargo.com Eugenio J. Alemán, Senior Economist… …………eugenio.j.aleman@wellsfargo.comeugenio.j.aleman@wellsfargo.com Anika R. Khan, Senior Economist …. anika.khan@wellsfargo.comanika.khan@wellsfargo.com Senior Economists Erik Nelson, Economic Analyst erik.f.nelson@wellsfargo.comerik.f.nelson@wellsfargo.com Alex Moehring, Economic Analyst alex.v.moehring@wellsfargo.comalex.v.moehring@wellsfargo.com Misa Batcheller, Economic Analyst misa.n.batcheller@wellsfargo.commisa.n.batcheller@wellsfargo.com Michael Pugliese, Economic Analyst michael.d.pugliese@wellsfargo.commichael.d.pugliese@wellsfargo.com Julianne Causey, Economic Analyst julianne.causey@wellsfargo.comjulianne.causey@wellsfargo.com Economists Azhar Iqbal, Econometrician………………… ……………azhar.iqbal@wellsfargo.comazhar.iqbal@wellsfargo.com Tim Quinlan, Economist …………………… ……………..tim.quinlan@wellsfargo.comtim.quinlan@wellsfargo.com Eric J. Viloria, Currency Strategist eric.viloria@wellsfargo.comeric.viloria@wellsfargo.com Sarah House, Economist …………… ………… sarah.house@wellsfargo.comsarah.house@wellsfargo.com Michael A. Brown, Economist ……………… … michael.a.brown@wellsfargo.commichael.a.brown@wellsfargo.com Economic Analysts Administrative Assistants Wells Fargo Securities Economics Group publications are produced by Wells Fargo Securities, LLC, a U.S broker-dealer registered with the U.S. Securities and Exchange Commission, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. Wells Fargo Securities, LLC, distributes these publications directly and through subsidiaries including, but not limited to, Wells Fargo & Company, Wells Fargo Bank N.A., Wells Fargo Advisors, LLC, Wells Fargo Securities International Limited, Wells Fargo Securities Asia Limited and Wells Fargo Securities (Japan) Co. Limited. Wells Fargo Securities, LLC. ("WFS") is registered with the Commodities Futures Trading Commission as a futures commission merchant and is a member in good standing of the National Futures Association. Wells Fargo Bank, N.A. 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WFSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive 2007. The FCA rules made under the Financial Services and Markets Act 2000 for the protection of retail clients will therefore not apply, nor will the Financial Services Compensation Scheme be available. This report is not intended for, and should not be relied upon by, retail clients. This document and any other materials accompanying this document (collectively, the "Materials") are provided for general informational purposes only. Donna LaFleur, Executive Assistant. donna.lafleur@wellsfargo.com donna.lafleur@wellsfargo.com