Rush to Judgement · Q1 2016 Q2 2016 Q3 2016 Q42016 Q1 2017 Q2 2017 Q3 2017 2017 2018 Real GDP ......

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Rush to Judgement

March 2017

2

Conclusions

Domestic Economy

The shift in focus from monetary to fiscal policy stimulus is generally expected to prove successful in establishing a stronger

growth trajectory. Our expectation for growth and inflation are more modest than that being discounted by markets; however,

the bullish sentiment will dominate in 2017. Don’t ignore possible effects of Trumps “keep American Jobs in America”.

The anticipated Trump tax cut modeled on the Reagan stimulus plan faces excess supply not excess demand.. This

implies the long-term success of the program is in doubt, especially when demographic and relative market conditions are

taken into consideration. The Trump deregulation agenda is also much more limited that Reagan’s and their trade policies

are decidedly different.

Currency market dynamics will be the key to 2017 outlook as Japan and Europe remain stuck in deflation. The tax cut

assures a pick up in 2018; while, the longer-term outlook will depend more on what Trump can do to revive housing not

investment spending or trade.

No Recession Risk:

Despite increased leverage by the corporate sector and a shortening of duration by the households balance sheets remain

generally healthy.

Bank balance sheets have improved dramatically and even a modest easing of regulatory constraints will be credit positive.

The equity rally will help narrow spreads despite altered market dynamics as investors continue to grab yield.

The lack of corporate pricing power reflects excess supply of both tradable goods and commodities. Current Account data

support the excess supply story limiting the upside potential in long-term rates.

3

Model Based Real GDP Forecast/ Pre-Trump Victory

Mizuho U.S. Macro Forecast

Q1 2016 Q2 2016 Q3 2016 Q42016 Q1 2017 Q2 2017 Q3 2017 2017 2018

Real GDP (Q/Q%): 0.80% 1.4 3.5 1.9 2.25 2.3 2.5 2.3 2.50

Core PCE Deflator (y/y%) 1.2 1.3 1.75 1.75 2 2 2 1.68 1.75

Fed Funds Rate %* 0.25-0.5 0.25-0.5 0.25-0.5 0.5-0.75 0.75-1 1-1.25 1-1.25 1-1.25 1.5-1.75

10-year Note (%)* 1.92 1.75 1.56 2.13 2.75 3.00 2.75 2.50 2.50

Inflation no longer determines the business cycle

4

5

Credit flows determine business cycle

6

Credit cycles evolve differently than inflation cycles

7

Excess capacity is a global issue

8

Current account trends show excess supply

Total Credit to Non-Financial Sectors, including Government (% of GDP)

9

Production growth has been key to the shift to excess supply

10

Global trade helps explain shift to excess supply

11

Demographics is an important limitation of growth

12

Budget deficit limits benefit from fiscal stimulus

13

14

Monetary Policy

15

Dual mandate

Dual mandate

16

Dual Mandate

17

18

Financial system stress measures off their lows

19

Monetary policy remains accommodative

20

QE still accommodative

21

Liquidity issues, not credit deterioration, evident in spreads

Money market reform has effected spreads at the front end of the curve

22

23

Credit Considerations

24

Banks no longer easing lending standards (C&I loans)

25

Banks less aggressive in consumer lending

26

A lack of demand suggests banks are less accommodative than they indicate

27

Banking system restructuring nearing completion

Banking system restructuring nearing completion

28

Banks are a key reason for shallow growth trajectory

29

Corporate Spreads and Balance Sheet

31

Corporate sector leveraging its balance sheet

32

Corporate balance sheets becoming more levered

33

Energy has clearly affected bank performance

*Rebased 01/01/2015=100

34

Credit markets no longer a constraint on the economy

Corporate spreads reflect exposure as well as reduced liquidity

35

Non-financial corporate leverage has increased

36

Duration remains long

37

38

Corporate debt burden is healthy

Unique divergence in default rates

39

0

2

4

6

8

10

12

14

16

18 % Energy and natural resources All other sectors

Source: S&P

Household Balance Sheet

41

Household savings higher than before the financial crisis

42

Household deleveraging still underway

43

Consumer duration affected by auto leasing

44

Household debt burden is very low

45

Asset side of household balance sheet recovery has improved

Corporate share of national income has topped

46

Valuation Considerations

48

Low long-term rates has lifted the P/E

49

Stocks are expensive to NIPA profits

50

Stocks expensive to earnings

51

Deflation risks cannot be ignored

Consumers shift purchases to avoid price increases

52

53

Rent and healthcare pushing up PCE

54

Compensation shows no credible sign of acceleration

55

TIPS inflation breakeven below Fed PCE target

56

Liquidity premium remains evident in the market

Auto Appendix

58

Auto sales dominating retail activity

59

Auto assemblies out of step with the rest of manufacturing

Factory sector is still important

60

Median age of vehicles supports sales

61

62

Used car prices could become a negative for new car sales

Auto loan rates are at record lows

63

Sales of heavy trucks reflects reduction in global trade

64

Dealer inventory is a problem for industry

65

Housing market appendix

67

Housing market correction has run out of steam

68

Rising home prices supporting rent

Household formation not going to boost home demand

69

Homeowner vacancy rate no longer a drag

70

Rental vacancy rate suggests overbuilding a regional problem

71

72

Restructuring has kept LTV high

73

Recovery in new starts is shallow

Single family demand may be recovering

74

Oil appendix

Estimated total OPEC Crude Oil Production

76

U.S. crude oil inventory and WTI

77

International appendix

World GDP Breakdown, Pre-Reagan (1981-1989) vs now

79

Gross domestic product, current prices 1980 $Bln 2015 $Bln

US 2,862.48 17,947.00

Eurozone 2,828.99 11,530.91

Japan 1,086.99 4,123.26

China 302.94 10,982.83

ROW 4,017.28 28,586.99

World 11,098.68 73,170.99

US, 2,862.48 , 26%

Eurozone, 2,828.99 ,

25%

Japan , 1,086.99 ,

10%

China, 302.94 , 3%

ROW, 4,017.28 ,

36%

1980 $Bln

US, 17,947.00 ,

24%

Eurozone, 11,530.91 ,

16%

Japan , 4,123.26 , 6%

China, 10,982.83 ,

15%

ROW, 28,586.99 ,

39%

2015 $Bln

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