Economic Update March 2012

1. Economic Update March 2012

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3. Year/Year Real GDP Quarterly Real GDP (annualized rate) +3.0% +1.6% Source: Bureau of Economic Analysis • The acceleration in real GDP growth to 3.0% annualized in 4Q-11 from 1.8% in 3Q-11 suggests that the recovery is gathering momentum. However, the largest portion of this growth, 1.9% , came from increases in inventories. Real final sales grew by a tepid 1.1%. Part of this inventory build was due to the rundown in inventories in 3Q-11. If this inventory build is not continued in 1Q-12, slower inventory growth will be a drag on GDP. • The year/year growth in real GDP was 1.6% (4Q-11/4Q-10) – a very anemic growth rate. As a point of comparison the year/year growth in real GDP in 2010 was 3.1%. • One of the biggest detractors from real GDP growth was government spending. Federal spending was down 6.9% from 3Q-11 and state spending was down 2.5% from 3Q-11. A big part of the federal decline was due to a reduction in defense spending which is a volatile component. Nevertheless, government spending is likely to be a net detractor from real GDP for the next few years. Page 3

4. Real Personal Consumption Expenditures +2.1% Source: Bureau of Economic Analysis • Real consumption growth improved from 1.7% in 3Q-11 to 2.1% in 4Q-11. This growth has only been possible because households have been willing to dip into their savings. • The primary driver of personal consumption expenditures is real disposable income. Real disposable personal income (RDPI) increased 1.3% in 2011 while real personal consumption expenditures increased 2.2%. Additionally, the RDPI increase in 2011 was down from a 1.8% increase in 2010. • Given the modest expectations for real disposable personal income growth, the outlook for real personal consumption expenditures also remains less than robust. Page 4

5. Personal Consumption Expenditures Source: Bureau of Economic Analysis, Haver Analytics • Consumption cannot be expected to propel the economic recovery into a higher gear when income growth is set to remain weak and households continue to reduce leverage. • Subdued income growth and a desire to rebuild savings means that consumption growth is likely to remain tepid throughout 2012. • Household debt to disposable income has improved from 135% to 120% (largely due to defaults on existing loans). Until this ratio reaches 100%, however, households cannot be relied on to drive the overall economic recovery. Page 5

6. Real Disposable Personal Income Source: Bureau of Economic Analysis Page 6

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8. Real spending has been rising faster than real disposable income for a year. This has driven the saving rate down to 4.6%. • It would appear that a 3.5% to 4.0% savings rate is about as low as consumers are willing to go until they see better employment prospects or better income growth rates. • Accordingly, the majority of further improvement in personal consumption expenditures will have to come as a result of improvement in these two factors. Dipping into savings should be viewed as less of a potential source of spending going forward. Page 8

9. Leading Economic Indicators v Real GDP Source: Bureau of Economic Analysis • Leading Economic Indicators continue to forecast slow, but positive, growth for the economy. • A low growth economy runs the risk that any economic disturbance could cause activity to turn negative. At the same time, a low growth economy does little to significantly reduce the unemployment situation. Page 9

10. Industrial Production Source: Federal Reserve Board • The strongest sector of the economy continues to be the manufacturing sector as shown above. The manufacturing sector has consistently been a source of economic growth during this otherwise disappointing recovery. The relatively weak dollar accompanied by the development of global markets have been the two primary reasons for this strength. The U.S. continues to produce the largest manufacturing output of any country. Page 10

11. Headline Inflation Indices Yr /Yr Producer Price Index (PPI) = 3.4% Yr /Yr Consumer Price Index (CPI) = 2.9% Bureau of Labor Statistics Core Inflation Indices Yr /Yr Core Consumer Price Index (CPI) = 2.2% Yr /Yr Core Pers. Cons. Exp. Index (PCE) = 1.9% Yr /Yr Core Producer Price Index (PPI) = 2.9% Bureau of Labor Statistics • Recent consumer price data are a mixed bag. Headline inflation fell to a ten-month low of 2.9%, from 3.0%, while core inflation remains near a three-year high at 2.2%.  • The headline rate is likely to move lower over the next few months, assuming that the recent spike in crude oil prices doesn't get any worse, but the decline in core inflation is likely to be much more gradual. Page 11

12. The persistent weakness in the multiplier indicates that most of the liquidity that the Fed is providing remains trapped in the banking system and is not being used to originate loans. The multiplier measures how much of the Fed’s money supply is translating into credit growth. • The January Fed Senior Loan Officer survey suggests that banks are seeing increased loan demand in most areas. If this phenomenon persists, we should begin to see improvement in the multiplier. • Until the multiplier begins to improve in earnest, however, upside inflationary pressures will have a difficult time getting any traction. Page 12

13. The strong money supply growth that we are currently experiencing (in a non-recessionary environment) has historically led to further economic growth and the development of inflationary pressures that must be managed by the Federal Reserve. The weak multiplier (on the preceding slide) is offsetting much of the impact of this money supply growth. However, if the multiplier begins to strengthen on a sustained basis, expect the growth rate of the money supply to move lower in order to curtail potential inflationary pressures. Page 13

14. Capacity utilization has improved over the past year, yet remains at a level that suggests that there is considerable slack in the economy. Core inflationary pressures will likely remain in check as long as this indicator remains below 80. Page 14

15. Unit labor costs are beginning to increase as the labor market continues to incrementally improve and productivity eases. This acceleration in labor costs needs to be monitored closely. With labor costs accounting for approximately 2/3 of business costs, a persistent acceleration in labor costs will be supportive to long-term inflationary pressures. Page 15

16. On a year over year basis, loan growth is starting to accelerate, particularly over the last six months. Since March 2010, loan growth has increased by $300 billion. • January’s Fed Senior Loan Officer Survey stated that, for the second quarter in a row, banks with headquarters in Europe tightened lending standards. • At the same time, the survey reported that almost all types of loan categories are seeing increased demand. This is a clear change from reports of the past couple of years. Page 16

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20. Consumer Credit Source: Federal Reserve, Haver Analytics Page 20

21. -2.0% -6.4% -1.5% -1.3% -3.1% -1.5% -2.8% • February’s Employment report adds to the evidence that the labor market has turned a corner. Non-farm payrolls increased by 227,000 in February, and upward revisions added an additional 61,000 to the gains in the two months before that. • The unemployment rate remained unchanged at 8.3%. This was due to the fact that 476,000 people came back into the labor force, more than matching the 428,000 increase in the household measure of employment. Page 21

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23. Nonfarm Payrolls Source: Bureau of Labor Statistics Page 23

24. Employment Trend Index v Total Nonfarm Payrolls Source: Bureau of Labor Statistics; Conference Board • The Employment Trend Index (ETI) offers a short-term, forward look at employment. The ETI aggregates eight labor market indicators from different sources that together act as a leading indicator for employment. • According to the ETI, job prospects are strengthening and should enable the slow but steady improvement in the labor market to continue. Page 24

25. Employment Trend Index v Total Nonfarm Payrolls Yearly Change Source: Bureau of Labor Statistics; Conference Board • The Conference Board’s Employment Trend Index leads payroll growth by about three months. • Historically, the year/year ETI has declined below 0% about 3 -4 months prior to the onset of a recession. Page 25

26. The decline in the unemployment rate since its peak in October 2009 is due to a 3.2 mil. total • increase in the household measure of employment, coupled with a 600K increase in the labor • force. The increase in employment is obviously good news. However, the addition of 3.2 mil. net • new jobs over the past 27 months averages out at a very modest 118K per month. At the same time, the labor force has increased by only 22K per month. Historically, the labor force has grown 1% per year or about 115K per month. • The drop in the unemployment rate doesn't so much reflect an improving job market as much as it does a slowdown in labor force growth. Page 26

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28. The decline in the employment-population ratio is a function of demographics and discouraged working age people dropping out of the workforce. Demographics is the bigger of the two factors, and indicates that with the ageing of the population, we are more likely to see the labor participation rate decline and only very modest growth in the labor force. • This smaller work force means, barring a pickup in productivity growth, the economy’s potential growth rate will decline to approximately 2% from 3.25%. • Based on the recent employment report, this ratio increased to a 20-month high of 58.6%. Nevertheless, it is important to note that the recent decline in the unemployment rate has not been accompanied by a significant rise in the share of the population employed. Page 28

29. Corporate Profits Quarterly Profits (current quarter vs. same quarter prior year) Year/Year Profits +10.5% +7.5% Source: Bureau of Economic Analysis Page 29

30. One reason that we have seen improvement in the labor market despite lackluster real GDP improvement is that productivity growth has stalled. Productivity only grew 0.5% from 4Q-10 to 4Q-11, and is likely to turn negative on a year/year basis in Q1-12. • The cyclical slowdown in labor productivity growth suggests that the corresponding slowdown in corporate profit growth has further to run as profit margins are coming under pressure. Page 30

31. Senior Loan Officer Survey – Net Percentage Tightening Standards Source: Federal Reserve Board • Overall, in the January survey, domestic banks reported that their lending standards had changed little and that they had experienced somewhat stronger loan demand in all major categories over the past three months. • Regarding business loans, domestic banks reported, on balance, little change in standards on commercial and industrial (C&I) loans but a continued easing of pricing terms on such loans during the fourth quarter. • Domestic banks continued to report little change in their standards for CRE loans, but modest net fractions had eased some loan terms over the past year. Page 31

32. Case Shiller Composite 20 Home Price Index Source: Case-Shiller • The data is beginning to indicate bona fide improvement in the underlying fundamentals of housing. • The rise in home sales in each of the three months to December is the clearest sign yet that a modest housing market recovery is underway. New home inventories are at record low levels. • Pricing appears to be stabilizing, but is not expected to show significant improvement any time soon. • The Mortgage Bankers Association measure of 30-year mortgage rates fell to a record low of 4.1% in January, down from 4.8% a year ago. • Given the low median price of a home, the slow improvement in median income, and record low mortgage rates, housing is close to its most affordable level ever. Page 32

33. The improvement in existing home sales is being driven by a better economy and a slight easing in credit conditions. Sales have risen by 15% since July. Sales of new homes, however, have yet to benefit. This is because new homes are struggling to compete with deeply discounted foreclosures and short sales. • On the supply side, the months’ supply of unsold homes is slightly tighter than normal. In December, it would have taken 6.7 months to clear the market at the prevailing sales rate, down significantly from a peak of 11.3 in mid-2010. • Tighter supply conditions have been encouraging more homebuilders to start projects. Single family starts have risen 20% over the past year. • On the pricing side, distressed sales are continuing to drag house prices lower. However, according to CoreLogic, non-distressed house prices rose 0.9% in December leaving them only 1% lower than a year ago. Expect non-distressed prices to continue to benefit from the tighter supply conditions expected to continue through the year. • The lowest tier of the market has suffered the most price depreciation during the past year while the upper tier has declined the least. • The condition of the labor market has a powerful influence on home sales. For example, North Dakota and Nebraska have both seen employment and home sales rise strongly. If the national labor market continues to improve, the national housing market is also likely to continue to improve. Page 33

34. S&P/Case –Shiller Home Price Indices – Year/Year Change Source: Case Shiller Page 34

35. S&P 500 Index • Equity markets are reflecting an easing (not a resolution) of the concerns that dominated investors’ outlooks last summer. The S&P 500 has gained 27% since the October lows. The NASDAQ reached an 11-year high in February and the small-cap index has hit an all time high. • The monetary backdrop continues to be very accommodative and valuations are reasonable. • Most important for the U.S. equity market is the domestic earnings outlook. The risk of a double-dip recession has eased, but for the S&P 500 to move higher investors will need some clarification on the sustainability of profit growth. Earnings growth rates are at risk of slowing over the next few years and margin pressures are likely to increase as productivity growth decelerates. Page 35

36. S&P Financial Sector / S&P 500 Index ? • The relative performance of the Financial Sector has started to show some early signs of improvement. It is no coincidence that this is occurring at the same time that we are seeing nascent improvement in banking activity. Given the regulatory and macro-economic backdrop that exists today, we do not expect to see a rapid acceleration in the performance of the financial sector relative to the overall market, but rather a slow and grinding improvement. Continued improvement in this relationship would be an indicator of a building self-sustaining recovery. Page 36

37. Parting Thoughts • The recent improvement in the incoming economic data, particularly in the labor market, has raised hopes that the US economy is embarking on a more vigorous self-sustaining recovery. Domestic economic conditions appear to be on a firmer footing with genuine signs of improvement in both housing and credit, and continued strength in the manufacturing sector. Nevertheless, the US remains at risk to an external shock, be it from Europe ,the Middle East or increasing oil prices. A Greek default and exit from the Euro-zone remains a high probability event. • Last year at this time, many domestic economic indicators were in similar positions, only to be negatively impacted by the Japanese disaster and higher oil prices. • Even if the external risks fail to materialize in 2012, it is important to remember that monetary and fiscal policy won’t be providing much support. After growing rapidly between 2008 and 2010, Federal discretionary spending is now set to contract sharply, impacting GDP by nearly 2% in 2013. Of course another short-term fix by Congress could mitigate the scheduled spending reductions, but such a move would simply move the problem down the road once more. • The US debt situation remains unresolved. In January, Fed Chairman Bernanke and the non-partisan CBO issued a stark warning about the fiscal path that America is heading down. Unless corrective action is taken, by the end of this decade Federal debt will have ballooned to 90% of GDP. That would put the US in the same club as the peripheral euro-zone nations that have seen their borrowing costs soar and fears of default surge. • Recent economic data strength has reduced the near-term prospects of another round of quantitative easing. However, if an external shock develops that impacts money and credit in the US, it is very realistic to expect the Fed to respond with another round of quantitative easing, perhaps coupled with Operation Twist II. Page 37

38. Disclaimer These statements are the opinion of Marquette Asset Management, Inc. and are subject to change without notice. This information is not intended to be used as the primary basis for investment decisions and should not be construed as advice designed to meet the particular investment needs of any investor, as individual investment plans will vary based on investment objectives and a number of additional factors. Please remember that past performance is no indication of future results and this publication makes no representation concerning actual future performance of the markets or economy. Please consult with your tax preparer and/or legal counsel as appropriate.