1. Navigating the New Normal: Portfolio Management in a Post- Crisis World Portfolio Management Institute Atlanta, Georgia April 22, 2010

2. Portfolio Management in a Hostile Environment Portfolio Management Institute Atlanta, Georgia April 22, 2010

3. Overview Bottom line: From crisis to crisis Bottom line: From crisis to crisis Approach Approach Baseline Baseline Threats Threats Opportunities Opportunities Mid-Terms Mid-Terms

4. Baseline Economics Next 12 to 24 months – 2 to 4 % growth Next 12 to 24 months – 2 to 4 % growth Then – 4 to 5 % growth until mid 2 ought teens Then – 4 to 5 % growth until mid 2 ought teens Then about 2.5 % annual Then about 2.5 % annual Inflation near 2 % through 2010 Inflation near 2 % through 2010 Rising to 3 + % by late 2011/early 2012 Rising to 3 + % by late 2011/early 2012 Returning to 2 % by 2013 Returning to 2 % by 2013 Interest rates + 100 bp then tracking inflation Interest rates + 100 bp then tracking inflation

5. Investors’ Threat # 1 Inflation Timeframe: late 2011 Timeframe: late 2011 Starts and ends with the Fed Starts and ends with the Fed Can the Fed nix inflation? Can the Fed nix inflation? Excess reserves Excess reserves

6. Investors’ Threat # 1 Inflation Timeframe: late 2011 Timeframe: late 2011 Starts and ends with the Fed Starts and ends with the Fed Can the Fed contain inflation? Can the Fed contain inflation? Excess reserves Excess reserves Velocity Velocity

7. Investors’ Threat # 1 Inflation Timeframe: late 2011 Timeframe: late 2011 Starts and ends with the Fed Starts and ends with the Fed Can the Fed contain inflation? Can the Fed contain inflation? Will it? The beguiling role of excess capacity Will it? The beguiling role of excess capacity

8. Investors’ Threat # 1 Inflation Timeframe: late 2011 Timeframe: late 2011 Starts and ends with the Fed Starts and ends with the Fed Can the Fed contain inflation? Can the Fed contain inflation? Will it? The beguiling role of excess capacity Will it? The beguiling role of excess capacity Response means slowdown 6 to 9 mos. later Response means slowdown 6 to 9 mos. later

9. Investors’ Threat # 2 Washington Anti-Investor Class Already extended 3.8% payroll tax to capital income Already extended 3.8% payroll tax to capital income Obama proposed 20% tax on cap gains and dividends Obama proposed 20% tax on cap gains and dividends Obama proposed $3.5 million/45% death tax Obama proposed $3.5 million/45% death tax Cap’N Tax Cap’N Tax

10. Investors’ Threat # 3 Sovereign Debt It could all begin in Greece It could all begin in Greece European Contagion European Contagion Tidal waves flow in, and out Tidal waves flow in, and out States join in – deficits and unfunded retiree benefits States join in – deficits and unfunded retiree benefits And then there’s Washington And then there’s Washington

11. Budget Deficits -- Unsustainable CBO, 3/2010 % of GDP

12. Federal Receipts Return to Normal CBO, 3/2010 % of GDP

13. Problem is Washington Spending Source: CBO 3/2010 Average = 20.3 % of GDP

15. Unsustainable Federal Debt CBO, 3/2010 % of GDP

19. Investors’ Threat # 3 Washington Taxes, Taxes, and a more Taxes VAT VAT Income Tax Income Tax Environmental Taxes Environmental Taxes

20. A Tale of Two Strategies Reagan – Starve the Beast Obama – Glut the Beast

21. A Tale of Two Strategies Reagan – Starve the Beast Reagan – Starve the Beast Obama – Glut the Beast Obama – Glut the Beast Massive spending increases Massive spending increases

22. A Tale of Two Strategies Reagan – Starve the Beast Reagan – Starve the Beast Obama – Glut the Beast Obama – Glut the Beast Massive spending increases Massive spending increases Spending as inevitable Spending as inevitable

23. A Tale of Two Strategies Reagan – Starve the Beast Reagan – Starve the Beast Obama – Glut the Beast Obama – Glut the Beast Massive spending increases Massive spending increases Spending as inevitable Spending as inevitable As act of God or nature As act of God or nature

24. A Tale of Two Strategies Reagan – Starve the Beast Reagan – Starve the Beast Obama – Glut the Beast Obama – Glut the Beast Massive spending increases Massive spending increases Spending as inevitable Spending as inevitable As act of God or nature As act of God or nature As long-term outcome As long-term outcome

25. A Tale of Two Strategies Reagan – Starve the Beast Reagan – Starve the Beast Obama – Glut the Beast Obama – Glut the Beast Massive spending increases Massive spending increases Spending as inevitable Spending as inevitable As act of God or nature As act of God or nature As long-term outcome As long-term outcome ANYTHING BUT A CONSCIOUS POLICY DECISION ANYTHING BUT A CONSCIOUS POLICY DECISION

27. Implication of Gluttony If much higher spending inevitable, then so are higher taxes If much higher spending inevitable, then so are higher taxes Corporate rate already too high Corporate rate already too high Rangel, Wyden-Gregg Rangel, Wyden-Gregg

29. Implication of Gluttony If much higher spending inevitable, If much higher spending inevitable, Then so are higher taxes Then so are higher taxes Corporate rate already too high Corporate rate already too high Rangel, Wyden-Gregg Rangel, Wyden-Gregg Current system nearly tapped out Current system nearly tapped out

30. Historical Perspective on the Fisc Average federal tax about 18.2 % of GDP Average federal tax about 18.2 % of GDP Average deficit = sustainable deficit about 2.2 % Average deficit = sustainable deficit about 2.2 % Average spending about 20.4 % Average spending about 20.4 %

31. Taxes, Or Not Existing system to 20 % of GDP Existing system to 20 % of GDP With 2 % deficit and 25 % spending With 2 % deficit and 25 % spending Leaves gap of 3 % of GDP Leaves gap of 3 % of GDP Absent fundamental entitlements reforms, long- run shortfalls much higher Absent fundamental entitlements reforms, long- run shortfalls much higher

33. Implication of Gluttony If much high spending inevitable, If much high spending inevitable, Then so are higher taxes Then so are higher taxes Corporate rate already too high Corporate rate already too high Rangel, Wyden-Gregg Rangel, Wyden-Gregg Current system nearly tapped out Current system nearly tapped out Must find another revenue source Must find another revenue source Answer – A VAT Answer – A VAT

34. The VAT Wave Volcker – AValue-Added Tax (VAT) “on the table” Volcker – AValue-Added Tax (VAT) “on the table” Brookings – 15 to 20 percent VAT Brookings – 15 to 20 percent VAT Congressional Budget Office – Studying VAT Congressional Budget Office – Studying VAT Tax Policy Center – A VAT to replace the payroll tax and corporate income tax Tax Policy Center – A VAT to replace the payroll tax and corporate income tax

35. What’s A VAT? An operational national retail sales tax An operational national retail sales tax Intended as an add on Intended as an add on VAT rates typically 15 to 20% VAT rates typically 15 to 20% EU minimum standard rate of 15% EU minimum standard rate of 15%

36. Glut the Beast = VAT Spending means fiscal policy unsustainable Spending means fiscal policy unsustainable Massive source of new revenues Massive source of new revenues 1 percentage point = net $50 billion in tax revenue 1 percentage point = net $50 billion in tax revenue 15 percent VAT = $750 billion in tax revenue 15 percent VAT = $750 billion in tax revenue 15 percent VAT -> 5 percent of GDP 15 percent VAT -> 5 percent of GDP

37. Why a VAT? Massive source of new revenues Massive source of new revenues VAT is among least damaging to economy VAT is among least damaging to economy VAT is nearly invisible to taxpayers VAT is nearly invisible to taxpayers

38. Investors’ Threat # 3 Glut the Beast – the Conclusion Sovereign debt crisis begins in Greece Sovereign debt crisis begins in Greece Flows across Europe to U.S. Flows across Europe to U.S. U.S. credit market crisis triggers a panic to act U.S. credit market crisis triggers a panic to act VAT plus other tax hikes, especially on capital VAT plus other tax hikes, especially on capital Or reverse Obama’s spending? Or reverse Obama’s spending?

39. Opportunities, Too Global economy more balanced (India, China, Brazil, etc.) Global economy more balanced (India, China, Brazil, etc.) Output Gap over 10 percent Output Gap over 10 percent Basic institutions remain sound Basic institutions remain sound Entrepreneurial spirit is alive Entrepreneurial spirit is alive The nation woke up The nation woke up Mid-Term Elections Mid-Term Elections

40. Portfolio Management in a Hostile Environment Portfolio Management Institute Atlanta, Georgia April 22, 2010

43. Portfolio Management in a Hostile Environment Portfolio Management Institute Atlanta, Georgia April 22, 2010