Capital Investment AdvisorsGoverning & Campaigning

In a De-Leveraging Environmenta

September 2012

Daniel CliftonHead of Policy Research

Strategas Research Partners

Key Policy Themes• The US Is Undergoing A Once In 70-Year

Deleveraging Process• Austerity Is Not A Winning Political Issue• Fiscal Cliff Is A Symptom of the Larger

Issues• The Bill Comes Due In ‘13 & Congress

Will Be Forced To Act On Tax/Spending• Energy Becomes The New Jobs Policy

Election 2012 Themes• Trajectory of the Economy Is Key• Presidential Approval Rating Is Best

Indicator To Watch• Approval Rating Has Been Tied To

Unemployment Rate• Equity Market Is Pricing In An Obama

Victory But Headwinds Remain• House Likely To Stay GOP• Senate is 50/50 At This Point

1. 2012 Pre-Election

2. 2012 Election Outcome

Mapping Out The Policy Landscape

3. 2012 Lame Duck Congress

4. 2013 Policy Implications

2012 Pre-Election

Countries Representing 50 Pct World GDP Changing Presidencies

# of G20 Presidential Elections & G20 GDP w/ Presidential Elections

0

1

2

3

4

5

6

7

8

'04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '140%

5%

10%

15%

20%

25%

30%

35%

40%

GDP of G20 Elections As Pct of World GDP

(Right Axis)

# of G20 Presidential

Elections (Left Axis)

Struggling Economy = Unpopular Incumbents

G20 Presidential Re-Election Trial Heats

48 4845

52

25

30

35

40

45

50

55

60

65

70

Obama Romney Sarkozy Hollande

France Election Results

United StatesGallup

9/6/2012

Large Budget Deficits & Debt Limit New Fiscal Policy Stimulus

Countries with Sovereign Rating of AAA2011 Surplus/Deficit & Debt as Pct. of GDP

-80%

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

-10% -8% -6% -4% -2% 0% 2%

US

UK Fra

CanAut

AusDen

Ger

Che

SweLux

Fin

Nld

Deficit/Surplus, Pct. of GDP

Net Debt, Pct. of GDP

The Challenge for Policymakers: Below Trend Economic Growth…

Real GDP has been below its long run average in 17 of the past 19 quarters

With A Rising Debt to GDP RatioFederal Net Debt To GDP

0

20

40

60

80

100

120

'40 '48 '56 '64 '72 '80 '88 '96 '04 '12 '20

If Current Polices Are Extended

CBO Forecast 2012 -2021

Keeping 2012 laws inplace will send Debtto GDP tounsustainable levels.Austerity has to occurwhile the economy isgrowing below trend.

Placing In Context The US Budget Challenge

Federal Debt Held by Public,Pct of GDP, 1790-2037

(CBO)

0

50

100

150

200

1790 1824 1858 1892 1926 1960 1994 2028

Civ il War

Great Depression

WWI

WWII

If 2012 Fiscal

Policy Is Extended

And Austerity Is Needed, Which Is Not A Winning Political Strategy

House Seats Changing Hands Between Parties By Election Year

-100 -50 0 50 100

1956

1954

1952

1950

1948

19461944

1942

1940

1938

1936

Seats Gained by Republicans

Seats Gained by Dem ocrats

Avg Change In House Seats 1938 - 1954,

39 Seats

The Bill Comes Due Post-Election

Net Federal Fiscal Stimulus, $BN

-200

-100

0

100

200

300

400

500

600

700

800

'01 '03 '05 '07 '09 '11 '13 '15 '17 '19

The fiscal cliffapproaching isabout $537bn in2013. The electionwill have anoutsized impact onhow the issue isresolved. But weare skeptical theentire drag can beoffset in 2013.

Forecast 2012-2021, Joint Committee On Taxation, Congressional Budget Office, Strategas

The Fiscal Cliff Could Serve As A Catalyst For A Grand Fiscal Deal

• Expiration of the Bush Tax Cuts• Expiration of the AMT Patch• Expiration of the Payroll Tax Cut/UI• Obama Healthcare Tax Increases Begin• 2009 Stimulus Spending Rolling Over• Sequestered Spending Take Effect• Debt Ceiling Will Need To Be Raised

Components of the Fiscal CliffFiscal Cliff Components, $BN, (CBO)

2010 Tax Cut Extension &

Index AMT For Inflation, 221

Other Changes in Revenue/

Spending, 105

Pay roll Tax, 95

Other Expiring Provisions, 65

Sequestration, 65

Unemploy ment Benefits, 26

Affordable Care Act Taxes, 18

Doc Fix , 11

This does not reflect the effects of Economic Feedback, -47

2012 Election

Equity Market Is Pricing In An Obama Victory

Dem Relative to GOP Stock Portfolio & Intrade Odds Obama Is Reelected

92

94

96

98

100

102

104

106

108

110

Jan-12 Mar-12 May-12 Jul-12 Sep-1246

48

50

52

54

56

58

60

62

64

66

Intrade Odds Of President Obama Being Reelected

Strategas Democratic Sweep Stock Portfolio Relative To GOP Sweep Stock Portfolio

Framework For Analyzing The 2012 Election

Campaign Narrative

Which Is It?:•Retrospective Referendum•Prospective

Choice

Economic Outlook

Trajectory:•Jobs, Gas Prices•Real Per Capita

Disposable Income

Swing States

State By State•State Economy•Demographics

Approval Ratings Dictate The Percentage Vote For An Incumbent

President Approval Rating & Pct of Presidential Vote

20%

30%

40%

50%

60%

70%

80%

Johnson*Nixon* Carter** Reagan BushI Clinton***Bush II

Pct of Vote

Approval Rating

October of Reelect ion Yea r , * Den otes

Nov em ber , **Septem ber , &

***Tw o Pa r ty V ote

Approval Ratings Are Key: Obama In A Grey Area

Presidential Approval Rating In September of Reelection Year

(Gallup)

0

10

20

30

40

50

60

70

80Tr

uman

Eis

enho

wer

John

son

Nix

on

Car

ter

Rea

gan

Bus

h I

Clin

ton

Bus

h II

Oba

ma

Won Re-Election

Lost Re-Election or Did Not Run

Will The Convention Bounce Last?President Obama's Approval Rating,

7-Day Rolling (Gallup)

42

43

44

45

46

47

48

49

50

51

52

1/4/2012 3/6/2012 5/7/2012 7/8/2012 9/7/2012

Last Click: 9/13, 49.8%

Ultimately, The Economy Is Driving The President’s Approval Rating

President Obama Approval Rating & Unemployment

38

40

42

44

46

48

50

8/1/11 11/1/11 2/1/12 5/1/12 8/1/12 11/1/12

7.4

7.6

7.8

8.0

8.2

8.4

8.6

8.8

9.0

9.2

9.4

Obama Approval Rating, Left

Unemploy ment Rate, Right, Inverted

Sept Avg = 49.1%

Obama Hoping For A Clinton “Glide Path” Effect

1996 Election:Registered Voters

(Gallup)

0

10

20

30

40

50

60

70

Jun 19 Jul 10 Jul 31 Aug 21 Sep 11 Oct 2 Oct 23

Clinton

Dole

PerotRepublican Convention

Aug 12 - 15

Democratic ConventionAug 26-29

President Still Needs Employment Growth Through The Election

Pct Chg In Nonfarm Payrolls In Re-Election Year & Two-Party Vote Pct

40%

45%

50%

55%

60%

65%

-1% 0% 1% 2% 3% 4%

Carter

ObamaBush I

Bush II

ClintonReagan

Johnson NixonPct of Two Party Vote

Pct Chg In Nonfarm Payrolls (Jan-Sep Re-Election Y ear)

Winning Cam paigns

Losing Cam paigns

Consumer Sentiment Has Been A Good Predictor of Reelection

U Of Mich Consumer Sentiment & Two Party Vote Pct

40%

45%

50%

55%

60%

65%

65 75 85 95 105

Pct of Two

Party Vote

University of Michigan Consumer Sentiment, Oct Of Re-Election Y ear

Nixon*

Reagan

Johnson*

Clinton

Bush II

Carter

Obama

Bush I *Signifies November data

After-Tax, After-Inflation Income Is A Good Predictor of Re-Election

Real Per Capita Income Growth & President's Re-Election Share of the Popular Vote

35%

40%

45%

50%

55%

60%

65%

-2% 0% 2% 4% 6% 8%

Reagan

Johnson

Nixon

Bush IIClinton

Bush IObama

Carter2010 Midterm

Winning Cam paigns

Losing Cam paigns

Real Per Capita Disposable Income, 4 QTR Rolling, Y /Y

Pct of Two

Party Vote

Key To States Is Watching Which Candidate Gets Over 50 Pct

Obama's AdvantageOver Romney By State

(RCP)

7 .7

3.5 3.32.4 2.3

1.4 0.7 0.6 0.6 0.2

-2.0

-6.0

-11 .0

-15

-10

-5

0

5

10

PA NH NV MI CO WI OH FL VA IA NC MO AZ

Monthly Change In President Obama's Advantage Over Romney In State Polling

(RCP)

-0.3

-2.2-2.0

0.6

-0.7

-2.1-1 .9

-1 .1

-1 .8

-2.3

0.0

-3.0

-4.2

-5

-4

-3

-2

-1

0

1

PA NH NV MI CO WI OH FL VA IA NC MO AZ

July 9 - Septem ber 7

Undecided Voters Break To The Challenger In Mid-October

2004 Presidential ElectionUndecideds Break To The

Challenger(Gallup)

52.0 50.7

44.048.3

20

30

40

50

60

70

Oct 16Poll

ElectionResult

Oct 16Poll

ElectionResult

George W. BushIncum bent

John KerryChallenger

1996 Presidential ElectionUndecideds Break To The

Challenger(Gallup)

54.049.2

41.0

48.9

20

30

40

50

60

70

80

Oct 19Poll

ElectionResult

Oct 19Poll

ElectionResult

Bill ClintonIncum bent

Bob Dole & Ross Perot

Challengers

Consensus Pointing To A GOP Sweep In Congress

Intrade Odds Of Republicans Controlling The Senate & House

40

50

60

70

80

90

100

1/1/11 5/1/11 9/1/11 1/1/12 5/1/12 9/1/12

Republicans Control the Senate

Republicans Control the House

Democrats On Defense In The Senate But Holding Strong

2012 Competitive Senate Races

8

43

7

1

5

1

1

3

0

0

2

4

6

8

10

12

14

Solid Likely Lean Toss Up Likely Lost

Democratic Seats Republican Seats

No Wave Election But Democrats Are Gaining MomentumGeneric Ballot, 4-Week Moving Average

(Rasmussen)

25%

30%

35%

40%

45%

50%

55%

7/6/2008 7/6/2009 7/6/2010 7/6/2011 7/6/2012

Midterm ElectionMass.

Special Election

2008 Election

GOP

Dems

Governing In Lame Duck & 2013

REMINDER: NEW CONGRESS FACES A MASSIVE FISCAL CLIFF

Net Federal Fiscal Stimulus, $BN

-200

-100

0

100

200

300

400

500

600

700

800

'01 '03 '05 '07 '09 '11 '13 '15 '17 '19

The fiscal cliffapproaching isabout $537bn in2013. The electionwill have anoutsized impact onhow the issue isresolved. But weare skeptical theentire drag can beoffset in 2013.

Forecast 2012-2021, Joint Committee On Taxation, Congressional Budget Office, Strategas

Fiscal Drag Is Twice The Size Of The Largest Post WWII Tax Increase

Size of Federal Tax Increases, Pct of GDP

1 .7 %

0.4% 0.4%

1.1%

0.2%

0.6%0.4%

0.6%

3.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

'68 '69 '80 '82 '84 '86 '90 '93 '13

T he com ing fiscal drag dwarfs the size of any previous tax increase

Two Catalysts For A Lame Duck Tax Bill: Debt Ceiling & AMT

Federal Debt Outstanding (Monthly, $TN)

7

8

9

10

11

12

13

14

15

16

17

Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Total Public Debt Subject to Limit

Debt Limit

Last Click: $15.5TN

Taxpayers Affected By AMT Under Various Scenarios

(JCT, Millions)

0

10

20

30

40

50

60

70

'10 '11 '12 '13 '14 '15 '16 '17 '18 '19 '20 '21 '22

Bush Tax Cuts Extended with AMT Patched

Bush Tax Cuts Extended Without AMT Patched

Current Law

Fiscal Cliff Implications• Fiscal Cliff Is Not Binary: Most But Not All

of the Cliff Gets Resolved By The End of the Year.

• Payroll Tax Cut Seems Unlikely To Get Extended At This Time

• Tax Increase of 3.8% on Investment Income Looks Difficult To Stop Regardless of Who Gets Elected

Tax On Investment Income Is A Backdoor Cap Gains & Dividend Tax

Capital Gains Realizations & Capital Gains Tax Rates

0%

2%

4%

6%

8%

'54 '64 '74 '84 '94 '045%

15%

25%

35%

45%

Hig h er Ra te = Low er

Rea liza t ion s Hig h er Ra te = Low er

Rea liza t ion

'86 Tax Increase

Cap Gains Realizations, Pct. of GDP (Left)

Cap Gains Tax Rate (Right)

2013 Fiscal Deal?

Growing Number of Catalysts For A Fiscal Deal In 2013

• Elevated Debt & Deficit Levels• Rising Interest Costs• Rating Agency Warnings• Subpar Economic Growth• Expiring Tax Provisions• Spending Sequester• Social Security Unfunded Liabilities• One Party Controlling Congress?

One Party Controlling Congress Gives Greater Fiscal Flexibility

Reconciliation Background• Legislative process established in

Congressional Budget Act of 1974 • Allows Senate to pass reconciliation

bill with simple majority, rather than 60 votes

• Eliminates a Senate filibuster• Debate limited to 20 hours• Requires House and Senate passed

budget resolution in place• Designed to speed passage of laws

impacting spending and taxes• Takes about six months to pass the

legislation into law.• In recent years, is used to pass fiscal

legislation lacking bi-partisan support such as the Bush tax cuts and Obama healthcare.

# of Votes for PassageRecent Reconciliation Bills

7 8

85

58

50

5456

40

45

50

55

60

65

70

75

80

85

90

'96 WelfareReform

'97 CapGains

'01 TaxCuts

'03 TaxCuts

'05 TaxCuts

'10 HealthCare

Crowding Out Effect ComingNet Interest Cost, Pct of Tax Revenues &

Avg. Annual 10-Year Treasury Yields

4

6

8

10

12

14

16

18

20

'53 '59 '65 '71 '77 '83 '89 '95 '01 '07 '13 '190

2

4

6

8

10

12

14

16

10 Y ear Treasury Y ield, Right

Net Interest Costs As Pct of Tax Revenues,

Left

Interest costs are set to explode despite

rates being kept low.

Source: OMB, Strategas, Forecast 2012 -2021

Healthcare & Interest Costs: 43% of Total Federal Spending By 2017

Healthcare Spending & Net Interest Costs As Pct. Of Total Federal Spending

0%

10%

20%

30%

40%

50%

'62 '68 '74 '80 '86 '92 '98 '04 '10 '16

Net Interest As Pct of Federal Spending

Healthcare Spending As Pct of Federal Spending

Healthcare & Interest Will Be 43% of Federal Spending in 2017

Forecast: OMB, Strategas

Meaningful Defense Cuts ComingCBO's Projected Defense

Spending In 2011 & 2012 Budget

250

350

450

550

650

750

850

950

'98 '00 '02 '04 '06 '08 '10 '12 '14 '16 '18 '20 '22

CBO's 2011 Budget Projections

CBO's 2012 Budget Projections

$1.2 T rillion Reduction In

Projected Defense Spending, -14.5%

Tax Reform Is The Best Way To Deal With The Fiscal Cliff But Challenging

Top Individual Tax Breaks for FY2014 With Expiring Provisions Extended

51.6

51.7

51.9

54

58.4

7 1.4

7 6.2

99.8

162.7

164.2

0 50 100 150 200

Charitable Contributions

Child Credit

Tax Breaks for Estate Assets

Deduction of Income Taxes

Earned Income Credit

Capital Gains Rates

Excl. of Medicare

Mortgage-Interest Deduction

Excl. of Employ er Pensions

Excl. of Employ er Health Ins.

Income Tax Shares, Pct of Income Taxes Paid

0

1020

30

4050

60

70

8090

100

Top 1% Top 5% Top 10% Top 25% Top 50% Bot 50%

2009

1986

Individual & Corporate Tax Reform Need To Move Together

Effective Corporate Tax RateBy Industry, 2007-2008

0%

5%

10%

15%

20%

25%

30%

35%

Uti

liti

es

Min

ing

Lea

sin

g

Tra

nsp

ort

Ag

ricu

ltu

re

Rea

l E

sta

te

Info

Tec

h

Insu

ran

ce

Ma

nu

fact

uri

ng

Avg

. E

ff.

Ta

xR

ate

Fin

an

ce

Co

nst

ruct

ion

Wh

ole

& R

eta

ilT

rad

e

Statutory Corporate Tax Rates By Region

20

25

30

35

40

45

50

55

'81 '84 '87 '90 '93 '96 '99 '02 '05 '08 '11

United States

OECD (ex-US)

Buffett Rule Is About Raising Capital Gains & Dividend Tax Rates

Buffett Rule Revenues & President's Budget Projected Spending

($ TN, 10-Year Estimate)46.96

0.050

5

10

15

20

25

30

35

40

45

50

Buffett Rule Revenue Obama's Projected Spending

Consensus Scenario• Obama wins presidency• GOP controls both houses of Congress• Lame duck bill extends some, but not all tax

cuts• Contentious 2013 fiscal deal could get done• Obama would need to sacrifice some HC

measures to get GOP to increase taxes• No deal = rolling debt ceiling increases• Obama uses his regulatory levers

Out of Consensus Scenario• Romney wins presidency• GOP controls both houses of Congress• All tax cuts get temporarily extended• Republicans complete a fiscal package of

tax and entitlement reform• Green light on energy development• Healthcare bill changed• Small changes to Dodd-Frank

Need To Identify Sectors Not Impacted By Austerity: Energy

Net Oil Imports: Share of U.S. Consumption

(EIA)

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

'73 '78 '83 '88 '93 '98 '03 '08

Energy Production Is Creating JobsNorth Dakota:

Oil Production vs. Mining Employment

0

4

8

12

16

20

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '120

4

8

12

16

20

Oil Production (Right scale, Millions of Barrels)

Mining and Logging Jobs (Left scale , in Thousands)

What To Watch For In 2012• President Obama’s approval rating• Unemployment Rate• Congressional generic ballot test• Federal Reserve/ECB Policy• Fiscal cliff negotiations• Iran negotiations• Social unrest in the U.S.

The Big Questions For 2013 & Beyond

• Next Federal Reserve Chairman• China Trade Policy• Tax Reform: REITs, Home Mortgage

Deduction, Capital Gains, Dividends, Carried Interest, Municipal Bonds, Estate

• Regulatory Policy

Questions?