Outlook for the Economy & Financial Markets

Robert GenetskiWebsite: ClassicalPrinciples.com

312-565-0112

Outline

I. Economic FrameworkII. US economic weaknessIII. Financial CrisisIV. Global Outlook: Europe, China, JapanV. Outlook for US Economy & MarketsVI. Take Away Points

Outline

I. Economic FrameworkII. US economic weaknessIII. Financial CrisisIV. Global Outlook: Europe, China, JapanV. Outlook for Economy 2013 & MarketsVI. Take Away Points

Outline

What causes booms and busts in the Economy?

1. Keynesian framework2. Classical framework

Classical Economic Principles 1. Low tax rates & limited government 2. Free Markets 3. Protect individual property rights 4. Sound money

Freedom & Prosperity

Least Free Third Second Most Free$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

Economic Freedom and Per Capita Income: 2010

Economic Freedom Quartile

Source: Fraser Institute, Economic Freedom of the World: 2012 Annual Report

Economic Freedom Quartile$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

$8,000

$9,000

$10,000

$11,000

$12,000Income of the Poorest 10%: 2010

Least Free Third second most free

Source: Fraser Institute, Economic Freedom of the World: 2012 Annual Report

Outline

I. Economic FrameworkII. US economic weaknessIII. Financial CrisisIV. Govt. Spending & Debt: US, Europe, ILV. Outlook for Economy & MarketsVI. Take Away Points

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1971

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1980

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1991

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1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

7.5

8.0

8.5

9.0

Economic Freedom: United States

score (10 = most freedom)

Source: Fraser Institute; Economic Freedom of the World, 2012 Annual Report; (5 year intervals until 2000)

1

6

11

16

US Economic Freedom Ranking

score (10 = most freedom)

Source: Fraser Institute; Economic Freedom of the World, 2012 Annual Report; (5 year intervals until 2000)

1970 1975 1980 1985 1990 1995 2000 2005 2010

1950

1951

1952

1953

1954

1955

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2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

3.8

3.9

4.0

4.1

4.2

4.3

4.4

4.5

4.6

4.7

4.8

Total Hours Worked: Actual & Potential(private nonfarm economy)natural log of the index

Source: Bureau of Labor Statistics, trend lines represent Census data for annual growth in working age population; calcu -lations by Robert Genetski, classicalprinciples.com.

Potential Hours Worked

Actual Hours Worked

1.7% trend: 1960-2000

1950

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2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

3.4

3.6

3.8

4.0

4.2

4.4

4.6

4.8

5.0

Productivity Trends(annual rates of change; private nonfarm business)

natural log of the index

classicalprinciples.com: Trends are from similar levels of operating capacity to avoid cyclical bias.

Long-term trend: 2.2%

Federal Spending & Private Spending with regs

2000-05 2005-10 2010-12 2010-12

Federal Govt. Spending: 38% 40% 2% 8%Private Spending 24% 9% 11% 8%

2000 2010 2012 2014 Annual Regulatory Compliance expenses: $1.0 $1.8 $2.0 $2.2(trillions of 2010 dollars)

Outline

I. Economic FrameworkII. US economic weaknessIII. Financial CrisisIV. Govt. Spending & Debt: US, Europe, ILV. Outlook for Economy &MarketsVI. Take Away Points

2001

2002

2003

2004

2005

2006

2007

2008

75

80

85

90

95

100

Adjusted Bank Reserves less Excess Reserve billions of dollars

Source: Federal Reserve Bank of St. Louis; classicalprinciples.com

(6-month average)

Not seasonally adjusted

2005 2006 2007 2008 2009 2010 2011 2012 201390

100

110

120

130

140

150

160

Adjusted Bank Reserves less Excess Reserve billions of dollars

Source: Federal Reserve Bank of St. Louis; classicalprinciples.com ; April, 2013 is an estimate based on partial data.

1 and 6-month end of period averages; annual growth rates in brackets Not seasonally adjusted

QE1

QE2

QE3

2005 2006 2007 2008 2009 2010 2011 2012 2013-6

-4

-2

0

2

4

6

8

10

12

Commercial Bank Loans & Investments(year over year percent chang)

percent

Outline

I. Economic FrameworkII. US economic weaknessIII. Financial CrisisIV. Global Outlook: Europe, China, JapanV. Outlook for Economy & MarketsVI. Take Away Points

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1981

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2015

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2017

2018

2019

2020

0

5

10

15

20

25

Total Output of Major Countries (Based on Purchasing Power Parity)

Japan

China

United States

India

France, UK

Germany

Brazil

Source: World Bank; IMF; classicalprinciples.com

trillions of constant US dollars

World’s Largest EconomiesSource: IMF

Share of Global Output2013 2018

United States 18.6% 17.7%China 15.6 19.0India 5.8 6.5Japan 5.5 4.7Germany 3.7 3.2Russia 3.0 2.9Brazil 2.8 2.8UK 2.7 2.4France 2.6 2.3Mexico 2.1 2.0

Government Spending as a % of Total Spending

2000 2013 2000-2013• France 52% 56% +4• Greece 47% 50% +3• Germany 45% 45% 0• UK 34% 44% +10• Spain 39% 42% +3• Japan 37% 41% +4• United States 34% 40% +6• Russia 33% 37% +4• India 25% 28% +3• China 17% 24% +7

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2013

2014

2015

5.0

6.0

7.0

8.0

9.0

Economic Freedom: Europe

score (10 = most freedom)

United Kingdom

Germany

ItalyGreece

France

Spain

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

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2011

2012

2013

2014

2015

3

4

5

6

7

Economic Freedom Score: China

score (10 = most freedom)

Source: Fraser Institute; Economic Freedom of the World, 2012 Annual Report; (5 year intervals until 2000)

1970

1971

1972

1973

1974

1975

1976

1977

1978

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1980

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2001

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2003

2004

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2010

2011

2012

2013

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2015

3

4

5

6

7

Economic Freedom: India & Russia

score (10 = most freedom)

India

Russia

China

1970

1971

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1973

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1977

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1980

1981

1982

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2003

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2007

2008

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2010

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2013

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6

7

8

9

10

Economic Freedom: Japan

score (10 = most freedom)

Japan

Net Government Debt to GDP• Greece 176%• Japan 143%• Italy 104%• US 89%• France 86%• UK 86%• Spain 79%• Germany 56%• Mexico 38%• Brazil 34%(China, Russia, India have no net debt)Source: IMF, World Economic Outlook Database, October 2012

Outline

I. Economic FrameworkII. US economic weaknessIII. Financial CrisisIV. Global Outlook: Europe, China, JapanV. Outlook for Economy & MarketsVI. Take Away Points

Factors Boosting the US Economy 2013-2014

• Banking system has substantial reserves• Fiscal agreement provides more stable tax

environment• With tax hikes off the table, greater chance of

slowing federal spending

Factors Restraining the US Economy 2013-2014

• higher tax burdens• regulatory burdens depressing productivity• regulatory burdens depressing job creation• regulatory pressure on banks to rebuild capital

and limit lending

Outline

V. Outlook for US Economy & Marketsa. Spending pace: 4%-5%b. Inflation: 2%-3% vicinityc. Real growth: 2%-3% vicinityd. Housing pricese. Goldf. Oilg. Interest ratesh. Stocks

Outline

V. Outlook for Economy & Marketsa. Spending pace: 4%-5%b. Inflation: 2%-3% vicinityc. Real growth: 2%-3% vicinityd. Housing pricese. Goldf. Oilg. Interest ratesh. Stocks

1996 97 98 99 2000 01 02 03 04 05 06 07 08 09 10 11 12 13$80,000

$120,000

$160,000

$200,000

$240,000

Housing Prices: US

US Composite

Case-Shiller Index of Existing Home Prices adjusted to dollar values

Source: S&P; classicalprinciples.com; Case-Shiller housing price index adjusted for average price of existing homes.

Home prices are undervalued

• 21% Based on Price to Income

• 8% Based on prices vs. rental costs

1976 1978 198019811982 198419851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010201120122013$100

$400

$700

$1,000

$1,300

$1,600

$1,900

Gold Prices: Actual & Fundamental

Raw Industrial Commodity Prices(indexed to gold (1976-2006)

()

Gold Price

1976 1978 198019811982 19841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009201020112012201310

30

50

70

90

110

130Oil Prices: Actual & Fundamental

Oil Prices

Oil Price-based on average oil/commodity price (1976-2004)

2000

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0

1

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7

Fed Funds Interest Rate

Actual

Forecast

Fundamental

Fundamental uses 0.5% real after-tax rate; 1 year average core inflation; 30% tax premium)

2000

2000

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1

2

3

4

5

6

7

10-Year Treasury Bond Rates: Actual & Fundamental

ActualForecast

Fundamental

(Fundamental is 1.4% real rate; 5-year inflation average cpi, gdp deflator; 25% marginal tax rate)

1946194719481949195019511952195319541955195619571958195919601961196219631964196519661967196819691970197119721973197419751976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009201020112012201320142015-2

-1

0

1

2

3

4

S&P 500 Profit Trend(quarterly profit data; 6.5% trend lines plus and minus 2

standard deviations)

natural log of profit per share

source: classicalprinciples.com (S&P earnings are through 3rd quar-ter of 2007; DJ earnings are through 2nd quarter.

n

S&P 500 Reported Earnings per share

source: classicalprinciples.com (S&P earnings are through 3rd quar-ter of 2007; DJ earnings are through 2nd quarter.

1947194819491950195119521953195419551956195719581959196019611962196319641965196619671968196919701971197219731974197519761977197819791980198119821983198419851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010201120122013201420153

4

5

6

7

8

S&P 500: Actual & Price Based on Average PE & Average Earnings Growth

natural log of both series

Actual Price

Source: classicalprinciples.com, Haver Analytics Fundamental is; based on regression using a 6.5% trend earnings and applying average PE = 17.4 for the period from 1947-2010

Fundamental with one standard deviation limits

19471948194919501951195253541955195619571958195919601961626319641965196619671968196919701971197219731974197519761977197819791980198119821983198419851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010201120122013201420153

4

5

6

7

S&P 500: Actual & Model

Fundamental with one standard deviation limits

natural logs

S&P 500 actual

(model based on a regression analysis where inputs include average P/E with stable 6.5% earnings growth and AAA corporate bond rates)

Source: classicalprinciples.com, Haver Analytics; average P/E = 17.4 from 1947-2010 measured as current quarter stock price divided by earnings over the past year.

19461947194819491950195119521953195419551956195719581959196019611962196319641965196619671968196919701971197219731974197519761977197819791980198119821983198419851986198719881989199019911992199319941995199619971998199920002001200220032004200520062007200820092010201120122013201420150

2

4

6

8

10

12

14

16

Earnings/Price S&P 500 & Interest Rates

E/P S&P 500reported earn-ings(thin line)

Moody's AAA bond yield

(Stock prices are current quarter; earnings are reported after-tax for past 4 quarters; operating earnings are shown beginning in 1988)

source: S&P; classicalprinciples.com

percent

Takeaway Points

• Odds are against economic collapse but… • US, Europe, Japan slow growth and decline in living

standards• Interest rates, inflation stock prices artificially low

– Avoid bonds– Consider price escalators in longer-term contracts

• Growth opportunities – areas promoting economic freedom – assist increase efficiencies for your clients– help individuals maintain living standards/save time

Questions or Comments

Robert GenetskiWebsite: ClassicalPrinciples.com

312-565-0112

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Robert Genetski312-565-0112