1. Fixed Income. Broken Dreams. 28 August 2013 War Room

2. HiddenLevers War Room Open Q + A Macro Coaching Archived webinars CE Credit Idea Generation Presentation deck Product Updates Scenario Updates

3. I.Market Volatility Update - Middle East Troubles - Debt Ceiling + Obamacare II.Macro Overview – Taper Coming? III.Fixed Income Broken IV.Winners + Losers in Rising Rates War Room

4. HiddenLevers MARKET VOLATILITY UPDATE

5. Middle East Troubles Syria Egypt 2013 Oil = 110 Syria conflict hurts Iran progress Oil near 2 year highs US attack = risk off Oil rally temporary source: HiddenLevers, US Energy Information Administration Initial Reaction = 3 month time frameUS Energy Information Administration Initial reaction Gulf War 1991 Iraq Invasion 2003 Right Now VIX+ 18%+ 50%+ 30 % S & P- 6%-7.2%+ 3 Oil+ 100%+ 66%+ 13% sources: HiddenLevers, Washington PostWashington Post

6. Arab Spring 2011 Remember the good old days Bob? Middle East Troubles Oil = 113 source: HiddenLevers

7. Watch out for biased research on Obamacare Debt Ceiling + Obamacare GOP divided on idea of using Government shutdown to defund Obamacare But House Majority Leader has suggested using Debt Ceiling negotiations to defund Obamacare – does this put default back on the table? Default is much bigger than Shutdown

8. Egypt = priced in govt shutdown = sick Syria = NOT priced in debt ceiling breach = dead Market Volatility – Recap

9. MACRO OVERVIEW – TAPER COMING? HiddenLevers

10. Macro Overview – Housing + Mortgage Rates Housing starts and home prices both rising since early 2012 100bp rise in mortgage rates – impact on home sales just beginning source: HiddenLevers

11. Macro Overview – Employment + CPI Housing starts and home prices both rising since early 2012 100bp rise in mortgage rates – impact on home sales just beginning source: HiddenLevers

12. Macro Overview – From the Horse’s Mouth Fed SpeakTranslation …as long as the unemployment rate remains above 6- 1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal… No rate hikes anytime soon “And if the subsequent data continued to confirm this pattern of ongoing economic improvement and normalizing inflation, we expected to continue to reduce the pace of purchases in measured steps through the first half of next year, ending them around midyear. At that point, if the economy had evolved along the lines we anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation would be moving toward our 2 percent objective.” - Ben Bernanke, 7/17/2013 If economy holds up, start taper in Sep ’13, and finish by mid-2014 I’m pretty sure he means it Wilbur.

13. The Long View – where are we on rates? Long-term (30yr) US interest rates have varied from 2% to 14%. Even with 10yr at 4% we will be below long-term average interest rates. This provides significant room for tapering as economy recovers. ~6% long term average for 30 year treasury

14. HiddenLevers FIXED INCOME BROKEN – CRISIS LOOMING?

15. Puerto Rico is close to needing a bailout Muni Bond Crisis – Scary Anecdotes Cook County, IL debt downgraded Muni bond sell off looks like Lehman Illinois pensions completely underfunded Harrisburg PA insolvent, selling assets Detroit files for bankruptcy, $18b owed source: Bloomberg, Marketwatch, WSJMarketwatchWSJ

16. Muni Bond Crisis – Reassuring Data $3.7 trillion $6.68 billion $189 billion $746 million 70% California’s last debt sale Bond market no longer views CA as distressed credit. Credit rating has been raised twice in 2013. US municipal bond market Amount of bonds cities + states have sold in 2013 only 10 percent off last year’s pace Marketshare of muni bonds held by Individual Investors source: Journal Gazette, WSJ, Forbes, ReutersJournal GazetteWSJForbes, Reuters Total defaults for first half 2013, including Detroit $6.4 billion of this is Detroit. 280 million of defaults otherwise.

17. Muni Bond Crisis – Comparisons Lehman comparisons irresponsible Fall in Munis tied to treasuries US 10y yields up 70% since 01/May Munis held ground better than US Treasuries Muni bond yields up 30% since 01/May Munis index -5% US Treasury Funds Dreyfus -15% T. Rowe Price -15% Moving together since July source: HiddenLevers, MarketwatchMarketwatch “Lehman moment” Maybe I should have dropped a Lehman bomb? Meredith Whitney

18. Muni Bond Crisis – Scenarios Bad Normal Interest Rate risk Ugly Dramatic rise in defaults

19. 1994 Bond Exodus – Massacre - $1.5 Trillion global bond market losses - yields spiked 275 basis points in 6 months - long term treasuries lost over 10% in 1994 - current lower rates = losses would be greater 8.0% 5.25% 50% rise

20. 1994 Bond Exodus – Historical Scenario 1994 bond crash was mainly an interest rate and bond market phenomenon, did not have negative economic impacts Stock market impacts were very mild, though volatility rose Unemployment dropped, GDP growth increased, and CPI was stable during this period

21. 1994 Bond Exodus – Precipitated by Fed? Greenspan’s Fed hiked the Federal Funds Rate 6 consecutive times – from 3.5% to 6% in a one year timespan. He then reversed course and cut rates for the most of the next 2 years.

22. 1994 Bond Exodus – No Stock Exodus What happens to stocks after the Fed begins to tighten policy? Average 1Y S&P Return post-tightening: 1965: S&P -12.2%1972: S&P 4.8%1987: S&P -6.2% 1994: S&P -4.6% 1.5%

23. New Bond Exodus? – Bond + Equity Outflows dateequitiesbonds 2/28/201111,6289,063 3/31/20112,13212,978 4/30/20116,34813,969 5/31/2011-4,20819,655 6/30/2011-22,20013,725 7/31/2011-31,6549,828 8/31/2011-28,113-4,132 9/30/2011-12,5559,782 10/31/2011-20,68711,992 11/30/2011-18,54719,077 12/31/2011-29,3459,800 1/31/2012-59326,526 2/29/20121,50034,715 3/31/2012-10,15730,854 4/30/2012-6,56324,734 5/31/2012-8,69219,013 6/30/2012-6,37016,388 7/31/2012-9,26225,074 8/31/2012-18,28831,625 9/30/2012-24,44629,174 10/31/2012-16,41834,517 11/30/2012-23,16923,734 12/31/2012-30,6667,250 1/31/201337,73732,801 2/28/201314,13120,283 3/31/201314,81216,144 4/30/20134,32012,055 5/31/20135,34212,196 6/30/2013-58-60,471 Weekly Net New Cash Flow (dollar figures in millions) dateequitiesbonds 7/2/2013180-6,284 7/10/20137,556-8,141 7/17/20133,653-3,251 7/24/20134,2092,159 7/31/2013713-6,970 8/7/20133,411-2,090 8/14/20131,498-3,908 8/21/20131,332-11,149 At MI6 we call that a smoking gun source: ICI Trends in Mutual Fund InvestingICI Trends in Mutual Fund Investing Bond outflows haven’t stopped Regular bond inflows until mid-2013 June 2013 the reckoning (dollar figures in millions) More likely Fed Taper than great rotation

24. WINNERS + LOSERS IN RISING RATES HiddenLevers

25. How to control duration? Shorten maturities Increase yield Hold to maturity Floating rate issues Higher yield considerations Increased credit risk Higher correlation to stocks Rising Rates: Duration and Rate Risk

26. Rising Rates: Impact by Bond Maturity What’s the impact of 150bp rise in 10y yields? -2.7% for short duration funds -20% for 20+ year maturities Average impact of -10% across maturities

27. Loser Mortgage REITS Winner Casualty Insurance Winner Property Insurance Rising Rates: Equities Winner Life Insurance Loser Home Builders Loser EM Bonds Rising Rates – Try Correlations Screener

28. New Headers + Style Disclosures – available to all subscribers Risk Profile – improved layout Trainings – new format Coming soon: 1. Asset Allocation: multiple categories on funds 2. Disclosure – auto-load in settings Product Update