Fixed Income. Broken Dreams. 28 August 2013

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

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

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

4. HiddenLevers Market Volatility Update

5. Middle East Troubles Syria Egypt 2013 Oil = 110 sources: HiddenLevers, Washington Post Oil near 2 year highs Syria conflict hurts Iran progress US attack = risk off source: HiddenLevers, US Energy Information AdministrationInitial Reaction = 3 month time frame Oil rally temporary

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

7. 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 Watch out for biased research on Obamacare

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

9. HiddenLevers MAcro Overview – taper coming?

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

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

12. Macro Overview – From the Horse’s Mouth Fed Speak Translation No rate hikes anytime soon …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… “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. Muni Bond Crisis – Scary Anecdotes Detroit files for bankruptcy, $18b owed Harrisburg PA insolvent, selling assets Illinois pensions completely underfunded Puerto Rico is close to needing a bailout Cook County, IL debt downgraded Muni bond sell off looks like Lehman source: Bloomberg, Marketwatch, WSJ

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

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

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

19. 1994 Bond Exodus – Massacre 8.0% 50% rise 5.25% - $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

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 1965: S&P -12.2% 1972: S&P 4.8% 1987: S&P -6.2% What happens to stocks after the Fed begins to tighten policy? Average 1Y S&P Return post-tightening: 1.5% 1994: S&P -4.6%

23. New Bond Exodus? – Bond + Equity Outflows (dollar figures in millions) Regular bond inflows until mid-2013 June 2013 the reckoning Bond outflows haven’t stopped source: ICI Trends in Mutual Fund Investing More likely Fed Taper than great rotation At MI6 we call that a smoking gun

24. HiddenLevers Winners + losers in rising rates

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

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