US Economy Cracks In The Foundation 9-10

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The U.S. Economy: Cracks in the Foundation?

Cliff Noreen, President – Babson Capital Management

September 21, 2010



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1

Disclosures

This document is intended only for purposes of presentation to and discussion with whom it has been

delivered by an authorized person, and may not be copied or redistributed. Nothing in this document is

intended to be taken by any person as investment advice, or a recommendation to buy, hold or sell any

security or other investment, or an offer to sell or a solicitation of offers to purchase any security or

other investment, nor does it purport to be a complete description of the terms of or the risks or

potential conflicts of interest inherent in any actual or proposed investment or other transaction.

Prior to entering into any investment, prospective investors should determine, in consultation with their

own legal, tax, regulatory, accounting and/or financial advisors the economic risks and merits, as well

as the legal, tax, regulatory and accounting characteristics and consequences, and the overall

suitability, of the transaction from the investors’ own standpoints, and decide whether they are able to

bear such consequences and assume such risks.

Although the information presented in this document has been obtained from sources that BabsonCapital believes to be reliable, Babson Capital cannot and does not make any representation as to its

accuracy, validity, timeliness or completeness for any purpose, nor does Babson Capital undertake to

update any of the information presented herein.

This document expresses Babson Capital’s views only as of the date identified on front of the document.

Babson Capital, its personnel and affiliates may give advice or take action in performing their duties

for various clients, or for their own accounts, on the date hereof or on any later date, that are notnecessarily consistent with the analysis and outlook set forth in this document.

© 2010 Babson Capital Management LLC. All rights reserved.



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What Does A Trillion Dollars Look Like?

Source: PageTutor.com

$100 bill $10,000 $1 Million

$100 Million $1 Billion

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A Trillion. . . The New Billion?

$1 Trillion

Source: PageTutor.com 3



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U.S. Accounts For Nearly One-Quarter Of $58 Trillion Global Economy

Data Source: CIA Factbook

Top 10 World EconomiesFiscal Year 2009 ($Trillions)

United

States,$14.3T

Japan, $5.1T

China, $4.9T

Germany, $3.4T

France, $2.7T

U.K., $2.2T

Italy, $2.1T

Brazil, $1.6T

Spain, $1.5T

Canada, $1.3T

Rest of World,

$19.2T

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Data Source: Ned Davis Research

U.S. Corporate Profits Have Rebounded To Near All-Time Highs

Inflation Adjusted Net Profits of U.S. CorporationsJune 1954 to June 2010

0

200

400

600

800

1,000

1,200

1,400

1,600

$ B

i l l i o n s

Net Profits (Trailing Twelve Months)

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S&P 500 Trailing Twelve Month Price-to-EarningsSeptember 1954 to September 2010

Data Source: Bloomberg

U.S. Equity Markets Remain Reasonably Cheap On A Historic Basis

0.0x

5.0x

10.0x

15.0x

20.0x

25.0x

30.0x

35.0x

S&P 500 P/E Ratio Average P/E Ratio

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0%

20%

40%

60%

80%

100%

120%

140%

Canada France Germany Italy Japan UnitedKingdom

United States

N e t G o v ' t

D e b t t o G D P

2005 2006 2007 2008 2009 2010P 2011P 2012P

Data Source: IMF - World Economic Outlook April 2010

Debt Across The Major World Economies Continues To Rise

Net Government Debt to GDP for Leading World Economies2005 to 2012 Projected

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120%

170%

220%

270%

320%

370%

1922-2000 2000-2010

Total U.S. Debt Has Increased Dramatically Over Last 10 Years

Data Source: Federal Reserve & Ned Davis Research

Total U.S. Credit Market Debt as % of U.S. GDPDecember 1922 to June 2010

Total Debt at 6/30/10: $52.1 Trillion= 357%

Total GDP at 6/30/10: $14.6 Trillion

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Financial & Household Sectors Have Driven Dramatic U.S. Debt Growth

Data Source: Federal Reserve

Components of Total U.S. Credit Market DebtDecember 1945 to June 2010

0

10

20

30

40

50

$ T r i l l i o n s

Government Debt(Fed, State & Local)

Corporations(Includes Financial)

Households & Other

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(1,500)

(1,300)

(1,100)

(900)

(700)

(500)

(300)

(100)

100

300

B u d g e t S u r p l u

s / ( D e f i c i t ) - $ B i l l i o n s

Actual Projected

Data Source: Ned Davis Research & Bloomberg

U.S. Is Facing Record Budget Shortfalls For Years To Come

U.S. Government Budget Surplus/(Deficit)December 1964 to December 2020 (projected)

Budget Deficit at 7/31/10: $1.2 Trillion = 8%Total GDP at 6/30/10: $14.6 Trillion

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Government Spending Continues To Well Outpace Revenues

U.S. Government Spending & Tax Revenue as Percentage of GDP1960 to 2014 (estimated)

Data Source: Census Bureau

0

5

10

15

20

25

30

P e r c e n t o f G D P

Deficit Tax Revenues Gov't Spending

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Gross Domestic Product & Government Debt Per U.S. HouseholdJanuary 1959 to June 2010

GDP Well Exceeds Total Government Debt Per Household

Data Source: U.S. Census Bureau & Ned Davis Research

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

GDP Per Household Gov't Debt Per Household

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45 States Are Projecting Budget Shortfalls In 2011 Totaling $93B

Projected State Budget Shortfalls By Percentage – Top 25 StatesFiscal Year 2011

Data Source: Financial Times

(15)

(10)

(5)

0

5

10

15

-30%

-20%

-10%

0%

10%

20%

30%

$ B i l l i o n s

T h o u s a n d s

% of State Budget National Average % Projected Budget Shortfall

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0%

5%

10%

15%

20%

25%

30%

35%

40%45%

50%

% o f T o t a l

U n e m p l o y e d

Unemployed 27+ Weeks Average

Data Source: Ned Davis Research

Duration Of Unemployment Is Currently At Unprecedented Levels

Workers Unemployed More Than Six MonthsJanuary 1950 to August 2010

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Data Source: First American CoreLogic

Millions Of U.S. Home Owners Remain Underwater

Percentage of Households with Negative Equity – Top 25 StatesAt June 30, 2010

0%

10%

20%

30%

40%

50%

60%

70%

80%

% of Outstanding MtgsNational Average 28%

Total U.S. Property Value (mortgaged) $12.7 TrillionTotal U.S. Mortg ages Outs tanding $ 8.9 Trillion

Average Loan-to-Value:Total U.S. 70%

Nevada 120%Arizona 94%Florida 90%Michigan 86%

Property values +-5%

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Data Source: Ned Davis Research & Bureau of Economic Analysis

Dramatic Fall Off in Home Purchases Has Hurt Overall GDP

U.S. Residential Investment as Percentage of GDPJanuary 1971 to June 2010

2%

3%

4%

5%

6%

7%

R e s i d e n t i a l I n v e s t m e n t a s % o f G D P

Recessions % of GDP Average

- $ 5 4 1

B i l l i o n

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U.S. Ten Year Treasury YieldsJanuary 1871 to August 2010

Data Source: Robert Shiller

Treasury Yields Are Near Historical Lows

0%

2%

4%

6%

8%

10%

12%

14%

16%

10 Year U.S. Treasury Yield Average

20



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Data Source: Barclays Capital

Credit Spreads Remain Above Long-Term Averages

Barclays U.S. Credit IndexJanuary 1990 to September 2010

0

100

200

300

400

500

600

O p t i o n A d j u

s t e d S p r e a d ( b p s

)

OAS Average OAS (1990‐2010) Average OAS (1990‐2007)

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Data Source: Barclays Capital


Barclays U.S. High Yield IndexJanuary 1994 to September 2010

0

400

800

1,200

1,600

2,000

O p t i o n A d j u

s t e d S p r e a d ( b p

s )

OAS Average OAS (1994‐2010) Average OAS (1994‐2007)

22



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Data Source: Credit Suisse


Credit Suisse U.S. Leveraged Loan IndexJanuary 1992 to September 2010

0

400

800

1,200

1,600

2,000

D i s c o u n

t M a r g i n ( b p s )

DM (3‐year life) Average DM (1992‐2010) Average DM (1992‐2007)

23



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Data Source: Credit Suisse


Credit Suisse Western European Leveraged Loan IndexJanuary 1998 to September 2010

0

400

800

1,200

1,600

2,000

D i s c o u n t M a r g i n ( b p s )

DM (3‐year life) Average DM (1998‐2010) Average DM (1998‐2007)

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Data Source: Bloomberg, Barclays Capital, Credit Suisse

Fixed Income Has Dramatically Outperformed Equities

U.S. Fixed Income Market Performance vs. EquitiesSeptember 2000 to September 2010

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

T o t a l R e

t u r n

Barclays U.S. Credit Index = 98%Barclays U.S. High Yield Index = 111%

Credit Suisse U.S. Leveraged Loan Index = 55%

S&P 500 = (11%)

Total Return (September 2000 -September 2010)

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The Economy Today: Positives & Negatives

NEGATIVES

World economy remains fragile and susceptible to shocks

The Fed has few options left to stimulate the economy

Millions of U.S. households currently have negative equity in their homes

The “real” unemployment rate remains near 17% and net new jobcreation continues to be anemic

Total U.S. public debt has increased nearly 40% since the beginning of

the financial crisis and has more than doubled over the last 10 years

State and Local governments remain under significant fiscal strain

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The Economy Today : Positives & Negatives

POSITIVES

Despite record deficits and historically low interest rates, the U.S. dollar

remains strong and continues to attract foreign capital

Cash balances of both corporations and individuals are high

Credit markets continue to rally with robust new issuance across allcorporate debt markets

Corporate earnings continue their strong upward trend and balance

sheets continue to improve

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Closing Thoughts



Questions?



Documents

US Economy Cracks In The Foundation 9-10