Fixed Income. Broken Dreams.28 August 2013

War Room

HiddenLevers War Room

Open Q + A

Macro Coaching

Archived webinars

CE Credit

Idea Generation

Presentation deck

Product UpdatesScenario Updates

I. Market Volatility Update- Middle East Troubles- Debt Ceiling + Obamacare

II. Macro Overview – Taper Coming?

III. Fixed Income Broken

IV. Winners + Losers in Rising Rates

War Room

HiddenLevers

MARKET VOLATILITY UPDATE

Middle East TroublesSyriaEgypt2013

Oil = 110

Syria conflict hurts Iran progress

Oil near2 year highs

US attack = risk off

Oil rally temporarysource: HiddenLevers, US Energy Information AdministrationInitial Reaction = 3 month time frame

Initial reaction

Gulf War 1991

Iraq Invasion2003

RightNow

VIX + 18% + 50% + 30 %

S & P - 6% -7.2% + 3

Oil + 100% + 66% + 13%

sources: HiddenLevers, Washington Post

Arab Spring 2011

Remember the good old

days Bob?

Middle East Troubles

Oil = 113

source: HiddenLevers

Watch out for biased research on Obamacare

Debt Ceiling + Obamacare

GOP divided on idea of using Government shutdown to defund Obamacare

But House Majority Leader has suggested using Debt Ceiling negotiations to defund Obamacare – does this put default back on the table?

Default is much bigger than Shutdown

Egypt = priced in

govt shutdown = sick

Syria = NOT priced in

debt ceiling breach = dead

Market Volatility – Recap

MACRO OVERVIEW – TAPER COMING?HiddenLevers

Macro Overview – Housing + Mortgage Rates

Housing starts and home prices both rising since early 2012

100bp rise in mortgage rates – impact on home sales just beginning

source: HiddenLevers

Macro Overview – Employment + CPI

Housing starts and home prices both rising since early 2012

100bp rise in mortgage rates – impact on home sales just beginning

source: HiddenLevers

Macro Overview – From the Horse’s Mouth

Fed Speak Translation

…as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal…

No rate hikes

anytime soon

“And if the subsequent data continued to confirm this pattern of ongoing economic improvement and normalizing inflation, we expected to continue to reduce the pace of purchases in measured steps through the first half of next year, ending them around midyear. At that point, if the economy had evolved along the lines we anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation would be moving toward our 2 percent objective.”

- Ben Bernanke, 7/17/2013

If economy holds up,

start taper in Sep ’13, and finish

by mid-2014 I’m pretty sure he means it Wilbur.

The Long View – where are we on rates?

Long-term (30yr) US interest rates have varied from 2% to 14%.

Even with 10yr at 4% we will be below long-term average interest rates.

This provides significant room for tapering as economy recovers.

~6% long term average for 30 year treasury

HiddenLevers

FIXED INCOME BROKEN – CRISIS LOOMING?

Puerto Rico is close to needing

a bailout

Muni Bond Crisis – Scary Anecdotes

Cook County, IL debt

downgraded

Muni bond sell off looks like

Lehman

Illinois pensions completely

underfunded

Harrisburg PA insolvent,

selling assets

Detroit files for bankruptcy,$18b owed

source: Bloomberg, Marketwatch, WSJ

Muni Bond Crisis – Reassuring Data

$3.7 trillion

$6.68billion

$189billion

$746million

70%

California’s last debt sale Bond market no longer views CA as distressed credit. Credit rating has been raised twice in 2013.

US municipal bond market

Amount of bonds cities + states have sold in 2013only 10 percent off last year’s pace

Marketshare of muni bonds held by Individual Investors

source: Journal Gazette, WSJ, Forbes, Reuters

Total defaults for first half 2013, including Detroit$6.4 billion of this is Detroit. 280 million of defaults otherwise.

Muni Bond Crisis – Comparisons

Lehman comparisonsirresponsible

Fall in Munis tied to

treasuries

US 10y yieldsup 70% since

01/May

Munis held ground better

than US Treasuries

Muni bond yields up 30% since 01/May

Munis index -5%

US Treasury FundsDreyfus -15%T. Rowe Price -15%

Moving together since July

source: HiddenLevers, Marketwatch

“Lehman moment”

Maybe I should have dropped aLehman bomb?

Meredith Whitney

Muni Bond Crisis – Scenarios

BadNormal

Interest Rate risk

UglyDramatic rise

in defaults

1994 Bond Exodus – Massacre

- $1.5 Trillion global bond market losses- yields spiked 275 basis points in 6 months- long term treasuries lost over 10% in 1994- current lower rates = losses would be greater

8.0%

5.25%

50% rise

1994 Bond Exodus – Historical Scenario

• 1994 bond crash was mainly an interest rate and bond market phenomenon, did not have negative economic impacts

• Stock market impacts were very mild, though volatility rose

• Unemployment dropped, GDP growth increased, and CPI was stable during this period

1994 Bond Exodus – Precipitated by Fed?

Greenspan’s Fed hiked the Federal Funds Rate 6 consecutive times – from 3.5% to 6% in a one year timespan. He then reversed course and cut rates for the most of the next 2 years.

1994 Bond Exodus – No Stock Exodus

What happens to stocks after the Fed begins to tighten policy?

Average 1Y S&P Return post-tightening:

1965: S&P -12.2% 1972: S&P 4.8% 1987: S&P -6.2%

1994: S&P -4.6%

1.5%

New Bond Exodus? – Bond + Equity Outflows

date equities bonds2/28/2011 11,628 9,0633/31/2011 2,132 12,9784/30/2011 6,348 13,9695/31/2011 -4,208 19,6556/30/2011 -22,200 13,7257/31/2011 -31,654 9,8288/31/2011 -28,113 -4,1329/30/2011 -12,555 9,782

10/31/2011 -20,687 11,99211/30/2011 -18,547 19,07712/31/2011 -29,345 9,800

1/31/2012 -593 26,5262/29/2012 1,500 34,7153/31/2012 -10,157 30,8544/30/2012 -6,563 24,7345/31/2012 -8,692 19,0136/30/2012 -6,370 16,3887/31/2012 -9,262 25,0748/31/2012 -18,288 31,6259/30/2012 -24,446 29,174

10/31/2012 -16,418 34,51711/30/2012 -23,169 23,73412/31/2012 -30,666 7,250

1/31/2013 37,737 32,8012/28/2013 14,131 20,2833/31/2013 14,812 16,1444/30/2013 4,320 12,0555/31/2013 5,342 12,1966/30/2013 -58 -60,471

Weekly Net New Cash Flow(dollar figures in millions)

date equities bonds

7/2/2013 180 -6,284

7/10/2013 7,556 -8,141

7/17/2013 3,653 -3,251

7/24/2013 4,209 2,159

7/31/2013 713 -6,970

8/7/2013 3,411 -2,090

8/14/2013 1,498 -3,908

8/21/2013 1,332 -11,149

At MI6 we call that a smoking gun

source: ICI Trends in Mutual Fund Investing

Bond outflows haven’t stopped

Regular bond inflows until

mid-2013

June 2013 the reckoning

(dollar figures in millions)

More likely Fed Taper than great

rotation

WINNERS + LOSERS IN RISING RATESHiddenLevers

How to control duration? Shorten maturities Increase yield Hold to maturity Floating rate issues

Higher yield considerations Increased credit risk Higher correlation to

stocks

Rising Rates: Duration and Rate Risk

Rising Rates: Impact by Bond Maturity

What’s the impact of 150bp rise in 10y yields?

• -2.7% for short duration funds

• -20% for 20+ year maturities

• Average impact of -10% across maturities

LoserMortgage

REITS

WinnerCasualty

Insurance

WinnerPropertyInsurance

Rising Rates: Equities

WinnerLife

Insurance

LoserHome

Builders

LoserEM

Bonds

Rising Rates – Try Correlations Screener

• New Headers + Style

• Disclosures – available to all subscribers

• Risk Profile – improved layout

• Trainings – new format

Coming soon:

1. Asset Allocation: multiple categories on funds

2. Disclosure – auto-load in settings

Product Update