Vining Sparks Economic Outlook 2012

Q2 2012 Economic Outlook The Sputtering Economy Why the U.S. Economy Has Not Achieved Escape Velocity Coming out of the Great Recession

Presented by: Craig Dismuke Chief Economic Strategist [email protected]

Recap Weak Growth Consumption Investment Risks to Stability Monetary Policy

0

1

2

3

4

5

6

FF 3M 1 2 3 5 7 10 30

Treasury Yield Curve Source: Bloomberg, Vining Sparks

1%

2%

One Year Later, Even Lower Yields

June 2012

June 2011

Average Since 1990

-130 bps


6/19/2012 Page 2

Weak U.S. Economy, Fed Action, Greece,

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

M J J A S O N D J F M A

Treasury Yields Sources: Bloomberg, Vining Sparks

GDP Revision

“Mid 2013”

U.S. Downgrade

Operation Twist

Dovish FOMC

“Late 2014”

Strong Payroll Report Greece Defaults

FOMC More Neutral

Payrolls Disappoint Spain Comes into Focus

Greek Plan Involves No New Money


6/19/2012 Page 3

0.0

0.5

1.0

1.5

2.0

2.5

A M J J A S O N D J F M A M J J A S O N D J F M A M J J A

Fed Funds Futures Contracts Source: Bloomberg, Vining Sparks

Expectations Drop Further

June 2012

June 2011

2014 2013 2012

0.5%


6/19/2012 Page 4

Growth Continues to Be Moderate


6/19/2012 Page 5

1.9

3.0

1.8 1.3

0.4

2.3 2.5

3.8 3.9 3.8

1.7

-0.7

-6.7

Mar-12Dec-11Sep-11Jun-11Mar-11Dec-10Sep-10Jun-10Mar-10Dec-09Sep-09Jun-09Mar-09

GDP Growth QoQ Annualized Source: Bureau of Economic Analysis, Vining Sparks

-10%

-5%

0%

5%

10%

15%

20%

-8 -6 -4 -2 0 2 4 6 8 10 12 14 16

Pe

rce

nta

ge o

f P

eak

GD

P

Quarters from Beginning of Recession

Change In GDP from Beginning of Recessions Source: Bureau of Economic Analysis, Vining Sparks

July 1981 Recession

July 1990 Recession

March 2001 Recession

December 2007 Recession

Recovery Not As Robust As Others


6/19/2012 Page 6

50%

60%

70%

80%

90%

100%

110%

120%

130%

140%

1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012

Household Debt as a Percentage of Disposable Income Sources: Federal Reserve, Vining Sparks

Average 1985-2000: 83%

Average 1962-1984: 63%

Current: 112%

Peak: 129%

Deleveraging Continues, More to Come


6/19/2012 Page 7

0

20

40

60

80

100

120

140

160

40

50

60

70

80

90

100

110

120

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Co

nfe

ren

ce B

oar

d

Un

iver

sity

of

Mic

hig

an

Consumer Confidence Sources: Conference Board, University of Michigan, Vining Sparks

University of Michigan

Conference Board

Confidence Rebounded, Still Low

Long-Term Average

Debt Ceiling Debate Great Recession


6/19/2012 Page 8

40

42

44

46

48

50

52

54

56

58

6,000

7,000

8,000

9,000

10,000

11,000

12,000

13,000

14,000

15,000

Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12

Ho

use

ho

ld N

et W

ort

h (

Trill

ion

s)

Do

w J

on

es

Ind

ust

rial

Ave

rage

Household Net Worth - Financial Assets Sources: Federal Reserve, Bloomberg, Vining Sparks

Household Net Worth – Financial Assets

Dow Jones Industrial Average

Rising Equity Prices Lifting Spirits

Quarter-End

-7.7%

+99.7%

Peak: $55.4 T

Nadir: $44.2 T

Current: $52.3 T


6/19/2012 Page 9

-500

-300

-100

100

300

500

700

2010 2011 2012

Tho

usa

nd

s

Monthly Change in Nonfarm Payrolls Sources: BLS, Vining Sparks

Monthly Change in Nonfarm Payrolls

3-Month Average

Payroll Growth Has Been Inconsistent

Current Total Nonfarm Payrolls 133.0 MM

Pre-Recession Total Nonfarm Payrolls 138.0 MM

3-Month Average Growth 96k

12-Month Average Growth 149k

Net Difference -5.0 MM


6/19/2012 Page 10

0%

2%

4%

6%

8%

10%

12%

1982 1987 1992 1997 2002 2007 2012

Headline Unemployment Rate Source: Bureau of Labor Statistics, Vining Sparks

Current: 8.2%

Peak: 10.0%

Unemployment Rate Dropping

Not in the Labor Force Employed

10% Peak

May 2011

May 2012

82.7 MM

85.7 MM

87.9 MM

138.4 MM

139.6 MM

142.0 MM


6/19/2012 Page 11

56%

57%

58%

59%

60%

61%

62%

63%

64%

65%

1982 1987 1992 1997 2002 2007 2012

Jobs/Population Ratio Source: Bureau of Labor Statistics, Vining Sparks

57.48%

Fundamental Shift in Labor Market

= [(Full Time x 1) + (Self Emp. x 1) + (Part Time x .5)] / Total Civilian Pop.


6/19/2012 Page 12

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

1985 1990 1995 2000 2005 2010

Ave

rage

Ho

url

y Ea

rnin

gs (

YoY)

Average Hourly Earnings YoY Source: Bureau of Labor Statistics, Vining Sparks

Earnings Growth Has Been Weak

1.7%

3.0%


6/19/2012 Page 13

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

2009 2010 2011 2012

Disposable Personal Income Growth Sources: Bureau of Economic Analysis, Vining Sparks

Disposable Personal Income, Adjusted for Inflation (3M/3M Ann.)

Disposable Personal Income (3M/3M Ann.)

Real Disposable Income Growth Weak

0.9%

3.5%


6/19/2012 Page 14

Cannot Use Home Equity This Time

3

5

7

9

11

13

15

17

50

70

90

110

130

150

170

190

210

230

250

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Ho

use

ho

ld N

et

Wo

rth

- T

rilli

on

s

S&P

Cas

eSh

iller

Ho

me

Pri

ces

Household Net Worth - Real Estate Sources: Federal Reserve, Bloomberg, Vining Sparks

Household Net Worth – Real Estate

S&P CaseShiller Home Price Index

2003 – 2007 Home Prices Up 54%

$2.2 Trillion Extracted

$13.5 T

$6.3 T


6/19/2012 Page 15

$200

$400

$600

$800

$1,000

$1,200

$1,400

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Bill

ion

s

Gross Private Investment (Chained SAAR) Sources: Bureau of Economic Analysis, Vining Sparks

Non-Residential Investment in Structures

Non-Residential Investment in Equipment

Residential Investment

6.3% of GDP

2.3%

Housing Suppressing Investment


6/19/2012 Page 16

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

0

200

400

600

800

1,000

1,200

1,400

2003 2005 2007 2009 2011

Exis

tin

g H

om

e Sa

les

in T

ho

usa

nd

s (S

AA

R)

Ne

w H

om

e S

ale

s in

Th

ou

san

ds

(SA

AR

)

New And Existing Homes Sales Sources: National Assoc. of Realtors, Vining Sparks

Existing Home Sales

New Home Sales

Home Sales Up, Still Low

4.62 MM

343k


6/19/2012 Page 17

0

500

1,000

1,500

2,000

2,500

2000 2002 2004 2006 2008 2010 2012

Tho

usa

nd

s

Total Building Permits by Type Sources: U.S. Commerce Department, Vining Sparks

Permits Up, Still Very Low

Multi-Family Permits

Single Family Permits

723k Total

2,263k Total


6/19/2012 Page 18

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2002 2004 2006 2008 2010 2012

CoreLogic Home Price Indices Sources: CoreLogic, Vining Sparks

National Home Price Index

National Home Price Index, Excluding Distressed

Non-Distressed Prices Finding Support


6/19/2012 Page 19

0

1

2

3

4

5

6

7

8

9

10

2000 2002 2004 2006 2008 2010 2012 2014 2016

Mill

ion

s

Home Inventory by Type Sources: National Association of Realtors, Mortgage Bankers Association, Vining Sparks

Applying 12-Month Rate of Change

Pre-Bubble Level

Existing Home Inventory

Shadow Inventory (MBA)

New Home Inventory

Pre-Bubble Level

Must Work through Excess Supply


6/19/2012 Page 20

Europe: A Debt Crisis and a Recession

Year-End Fiscal Cliff

Unwinding Monetary Accommodation

Oil Prices

Possibility of Inflation

Significant Risks to Economic Stability


6/19/2012 Page 21

-12

-10

-8

-6

-4

-2

0

2

Def

icit

2011 Estimated Budget Deficit as a Percentage of GDP Sources: European Commission Est., Vining Sparks

Maastricht Treaty Requirement

Debt Continues to Grow

-3.0%


6/19/2012 Page 22

0

20

40

60

80

100

120

140

2002 2003 2004 2005 2006 2007 2008 2009 2010

Debt as a Percentage of GDP Sources: Eurostats, Vining Sparks, Q3 2011 Est.

Italy (120%)

Greece (159%)

Spain (66%)

Portugal (110%)

Ireland (105%)

Euro Area (87%)

Maastricht Treaty Requirement

Debt Continues to Grow


6/19/2012 Page 23

-10

-8

-6

-4

-2

0

2

4

6

8

10

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

GDP (YoY) Sources: Eurostats, Vining Sparks, Q3 2011 Est.

Italy

Greece

Spain

Portugal Ireland

Euro Area

A Double Dip Makes Matters Worse


6/19/2012 Page 24

0

2

4

6

8

10

12

14

16

18

1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012

Trill

ion

s

U.S. Debt and Total GDP Sources: Treasury, Bureau of Economic Analysis, Vining Sparks

U.S. Fiscal Policymakers Face Tough Choices

Debt Ceiling Total U.S. Debt Outstanding Total GDP


6/19/2012 Page 25

Expiration of Bush Tax Cuts

Expiration of Payroll Tax Cut

Extension of Unemployment Insurance

$1.2 Trillion in Automatic Fiscal Cuts

Total: E3.5% GDP

$16.4 Trillion Debt Ceiling Will Be Hit

Moody’s, S&P, and Fitch Warnings

Year-End Fiscal Cliff


6/19/2012 Page 26

Fed Funds Target Rate – 0.00% to 0.25%

Fed Funds Rate Projections – “Late 2014”

Grown Balance Sheet: $2.88 Trillion

Operation Twist Ongoing, Ends June 2012

Longer Average Maturity

Talking Frequently about Housing

New Quantitative Easing Tabled for Now

Slightly More Hawkish Tone in April

Monetary Policy: Accommodative


6/19/2012 Page 27

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

2012 2013 2014 Longer Run

Federal Funds Target Projections by FOMC Members Sources: Federal Reserve Appropriate Pace of Policy Firming Chart, Vining Sparks

Projections Reveal Minor Shifts in Fed Sentiment

January FOMC Projection (Average)

April FOMC Projection (Average)


6/19/2012 Page 28

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

2.8

F M A M J J A S O N D J F M A M

Implied Future Inflation Rates Source: Bloomberg, Vining Sparks

5-Year TIPs Breakeven Rate

10-Year TIPs Breakeven Rate

Inflation Expectations Anchored

2.13%

1.69%


6/19/2012 Page 29

-4

-3

-2

-1

0

1

2

3

4

5

6

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Federal Reserve GDP Projections and Actual GDP Sources: Federal Reserve (Green Books and SEP), Vining Sparks

2 Years before Period 1 Year before Period

Actual

Average Variance from Actual 1 Year before Period: 1.3 2 Years before Period: 1.8

Projections Are Historically Unreliable


6/19/2012 Page 30

No Evidence of Rapid Economic Growth

Risks Creating Significant Market Volatility

Fed has been biggest buyer of Treasuries

$1.9 trillion in excess holdings to sell or let pay down

Longer yields are very low, in part because of Fed’s stance

*Drives Mortgage Rates Higher

Increases Government’s Borrowing Cost

Unwinds Spread Tightening in Other Sectors

A Tough Exit for the FOMC


6/19/2012 Page 31

Consumption Is Modest, but Household Finances Still Face Long-Term Headwinds

Watch Earnings and Disposable Income Growth

Housing Is Poised to Be Accretive to Growth, Still Need to Work through Foreclosure and Shadow Inventories

Watch Shadow Inventory and Building Permits

Overall Growth Will Continue to Be Modest

Risks to Economic Stability Are Significant

Exiting Accommodative Policies Will Be Very Tenuous for Fed – Unlikely to Do So Soon

Summary


6/19/2012 Page 32

INTENDED FOR INSTITUTIONAL INVESTORS ONLY. The information included herein has been obtained from sources deemed reliable, but it is not in any way guaranteed, and it, together with any opinions expressed, is subject to change at any time. Any and all details offered in this publication are preliminary and are therefore subject to change at any time. This has been prepared for general information purposes only and does not consider the specific investment objectives, financial situation and particular needs of any individual or institution. This information is, by its very nature, incomplete and specifically lacks information critical to making final investment decisions. Investors should seek financial advice as to the appropriateness of investing in any securities or investment strategies mentioned or recommended. The accuracy of the financial projections is dependent on the occurrence of future events which cannot be assured; therefore, the actual results achieved during the projection period may vary from the projections. The firm may have positions, long or short, in any or all securities mentioned. Member FINRA/SIPC.

6/19/2012 Page 33

Portfolio Strategies – Q2 2012 Presented by: Craig Dismuke Chief Economic Strategist [email protected]

Portfolio Strategies – Rate Environment

6/19/2012 Page 35

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

Fed Funds Futures Contracts Source: Bloomberg, Vining Sparks

5/31/2012

4/30/2012

3/30/2012

2/29/2012


6/19/2012 Page 36

0.28

0.71

1.65

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 10Y

Treasury Yield Curve Source: Bloomberg, Vining Sparks

6/7/2012

4/30/2012

5/31/2011


6/19/2012 Page 37

0

50

100

150

200

250

300

350

Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12

2s10s Spread Source: Bloomberg, Vining Sparks

2s10s Spread (137)

Average

+/- 1 SD


-20

0

20

40

60

80

100

120

140

160

180

Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12


2s5s Spread (43)

Average

+/- 1 SD0

20

40

60

80

100

120

140

160



5s10s Spread (94)

Average

+/- 1 SD

6/19/2012 Page 38


-10

0

10

20

30

40

50

60

70



2s3s Spread (11)

Average

+/- 1 SD

0

10

20

30

40

50

60

70

80

90



5s7s Spread (38)

Average

+/- 1 SD

0

20

40

60

80

100

120



3s5s Spread (32)

Average

+/- 1 SD

0

10

20

30

40

50

60

70

80

90



7s10s Spread (56)

Average

+/- 1 SD

6/19/2012 Page 39

0

20

40

60

80

100

120

140

160

180

Aug-07 Feb-08 Aug-08 Feb-09 Aug-09 Feb-10 Aug-10 Feb-11 Aug-11 Feb-12

5Y Bullet Spread / 5Y Treasury Source: Vining Sparks

Spread (31)

Average

+/- 1 SD

Portfolio Strategies – Relative Value

Agency

Treasury

6/19/2012 Page 40

0

20

40

60

80

100

120


5Y NC 1Y Spread / 5Y Bullet Source: Vining Sparks

Spread (11)

Average

+/- 1 SD

Callable

Bullet


6/19/2012 Page 41

0

50

100

150

200

250

300

350


15Y CC MBS Spread / 5Y Treasury Source: Bloomberg, Vining Sparks

Spread (96)

Median

+/- 1 SD

MBS

Treasury


6/19/2012 Page 42

-20

0

20

40

60

80

100

120


15Y CC MBS Spread / 5Y NC 1Y Source: Bloomberg, Vining Sparks

Spread (54)

Median

+/- 1 SD

MBS

Callable Agency


6/19/2012 Page 43

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12

15Y 4.00 Minus 30Y 4.00 MBS Price Source: Bloomberg, Vining Sparks

Price Diff. (-0.31)

Median

+/- 1 SD

30 Year

15 Year


6/19/2012 Page 44

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Aug-10 Feb-11 Aug-11 Feb-12

15Y 5.00 Minus 15Y 3.50 MBS Price Source: Bloomberg, Vining Sparks

Price Diff. (2.06)

Median

+/- 1 SD

3.50% MBS

5.00% MBS


6/19/2012 Page 45


6/19/2012 Page 46

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

2.00

3M 1 2 3

Sector Yield Curves - Short End Source: Vining Sparks

Treasuries

Agency Bullets

Agency 1Y Callables

PAC CMOs

Sequential CMOs

Corporates ('A' Rated)

Municipals (Taxables)

SBA (Premium Pool)


6/19/2012 Page 47

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

3 4 5 6 7 8 9 10

Sector Yield Curves - Belly Source: Vining Sparks

Treasuries

Agency Bullets

Agency 1Y Callables

PAC CMOs

Sequential CMOs



MBS (15 Year)

MBS (30 Year)


6/19/2012 Page 48

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

5.50

6.00

10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Sector Yield Curves - Long End Source: Vining Sparks

Treasuries

Agency Bullets

Agency 1Y Callables

PAC CMOs

Sequential CMOs



Portfolio Strategies A. Rate Environment

1. Low interest rates

2. Fed on hold – Staying in cash or overnights will be painful

3. Asymmetric interest rate risk

4. Yield curve has flattened, with the steepest part beyond 7 years

B. Sector Relative Value 1. Agency spreads are tight

2. MBS spreads are fairly tight, but prepay and extension risks are concerns

3. Corporate and municipal spreads remain relatively attractive

4. With long yields as low as they are, short-amortizing products with lockout make most sense

C. Concentration Risks 1. Longer maturity agencies

2. Mortgages with significant prepayment risk

1. Higher coupons

2. Fast prepays causing lower book yields

3. Longer maturity mortgages with too much extension risk or price volatility

4. Excessive short-term cashflow

6/19/2012 Page 49

Portfolio Strategies D. Portfolio Strategies

1. Optimize*

2. Invest cash

3. Push short cashflows out to 2013 and beyond when economics make sense

4. Consider sector swaps to take advantage of cross-sector relative value

5. Swap out of extension and/or prepayment risks in MBS

6. Reduce line items through odd-lot cleanups

6/19/2012 Page 50

Optimize: Finding the Best Sector Allocation

9.4% 14.1% 30.1% 65.0%

83.2% 80.3% 66.8% 33.7%

6/19/2012 Page 51

6/19/2012 Page 52

Invest Cash: The Cost of Waiting Is too High

Example Strategy

6/19/2012 Page 53

Example Strategy: Buy/Sell Details

6/19/2012 Page 54

Example Strategy: Cashflows

6/19/2012 Page 55

Example Strategy: Results A. Give Up 32 BPS Income

B. Take $10K Loss on $54 Million Transaction

C. Go into Sectors with Better Spreads

D. Dramatically Reduce Price Volatility (-7.63% +300)

E. Shortens Interest Rate Sensitivity

F. Push $5 Million of Cashflow from 2012 to 2017

6/19/2012 Page 56

INTENDED FOR INSTITUTIONAL INVESTORS ONLY. The information included herein has been obtained from sources deemed reliable, but it is not in any way guaranteed, and it, together with any opinions expressed, is subject to change at any time. Any and all details offered in this publication are preliminary and are therefore subject to change at any time. This has been prepared for general information purposes only and does not consider the specific investment objectives, financial situation and particular needs of any individual or institution. This information is, by its very nature, incomplete and specifically lacks information critical to making final investment decisions. Investors should seek financial advice as to the appropriateness of investing in any securities or investment strategies mentioned or recommended. The accuracy of the financial projections is dependent on the occurrence of future events which cannot be assured; therefore, the actual results achieved during the projection period may vary from the projections. The firm may have positions, long or short, in any or all securities mentioned. Member FINRA/SIPC.

Economy & Finance

Vining Sparks Economic Outlook 2012