Cornerstone Chartbook January 2012

PowerPoint Presentation: 

Copyright 2003-2012, All rights reserved. invest with cornerstone .com 01/10/2012 Quarterly Chartbook January 2012

PowerPoint Presentation: 

Copyright 2003-2012, All rights reserved. invest with cornerstone .com 01/10/2012 There is a Bubble In Safety

PowerPoint Presentation: 

Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Five key takeaways… Interest rates are too low. 2011 for bonds was akin to 1999 to technology stocks, and returns to bonds for the coming years will likely be truncated. Europe is the problem with equity markets, and the Germans have tough choices to make. The US economy is getting better, and we are trying to de-couple from the rest of the world. There remain a lot of key items to watch carefully, from short-term market indicators of fear to possible inflation.

Interest rates for US Treasuries: 

Interest rates for US Treasuries Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 The one year US Treasury (below) is far too low.

PowerPoint Presentation: 

Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Bid to Cover for 4 week US Treasury bills Yields for Microsoft bonds – one of the few true AAA credits remaining. While the type is small, those are negative yields to maturity for the upcoming 18 months.

Asset Class returns: 

Asset Class returns Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 This is from the Capital Spectator blog, and it further illustrates the aversion to risk during 2011. US bonds, as measured by the Barclays index returned 7.9% for the year, compared to 1% for US stocks.

But, this risk aversion is counter to broader economic trends.: 

But, this risk aversion is counter to broader economic trends. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 The white line in this chart is the Citigroup economic surprise index, which has been strong during the second half of the year. Note the historical correlation with interest rates for the 10 year US Treasury.

Why is there a bubble in safety?: 

Why is there a bubble in safety? Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 The markets are looking in the rear-view mirror for problems. Yes, there are some scary things that could happen, but their probabilities are low. There is not likely to be another AIG, Fannie Mae or Lehman Brothers in the near-term. But, market participants rank them as more likely because of their recent occurrence. There are, though, real problems with Europe and the design of the Eurozone . At this point, it’s all about Germany, the decisions they make and their role going forward.

Why is there a bubble in safety?: 

Why is there a bubble in safety? Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Tracking our interest rates and the exchange ratio for the Euro. This is a perfect example of the risk aversion exhibited in the markets right now.

The German’s Choices – Door # 1: 

The German’s Choices – Door # 1 Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Abandon the Euro for the Deutschmark - Letting the Euro fail in a disorderly manner. Yuck – This sets German economy back a generation because it needs a currency that is not as strong as the DM would be. Approximately 1/3 of the German economy is export-related, and the Deutschmark would be a strong and deep currency. Exports would cease to be competitive. A lack of exports in an economy that is dependent upon them would cause a severe recession that could take a long time to recover from and would result in a significant decline to the current standard of living.

The German’s Choices – Door # 2: 

The German’s Choices – Door # 2 Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Guarantee the government bonds of periphery Europe by issuing Eurozone debt that is primarily underwritten by the German citizens. Yuck –Germans paying for southern European profligacy with an estimated debt for each German citizen of 30,000 to 50,000 Euro! There is no increase in German sovereignty within the Eurozone , and the problem has been eliminated without significant consequences for the offending parties (nor rewards for those who have made issues go away).

The German’s Choices – Door # 3: 

The German’s Choices – Door # 3 Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Quantitative easing Yuck – The downside is the introduction of a moral hazard (which may set a precedent) with a side of inflation. Why is this unpalatable to the Germans? At present, the EU has a single mandate – to minimize and monitor inflation. Ther e isn’t latitude beyond this scope. The Germans have a historical aversion to inflation, and would not want to be party to setting a precedent that would involve moral hazard going forward. There is political pressure within Germany (and other responsible northern nations) to push for more austerity. We believe that this is the path that will ultimately be chosen, but the Germans lobbying for greater authority within monetary union going forward.

European exports: 

European exports Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Our exports to Europe are only 2.8% of our total GDP. Here is an interesting state-by-state breakdown.

But, correlation is higher than historically…: 

But, correlation is higher than historically… Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Significant problems in Europe would not reflect the minimal impact it would have to US GDP, rather global markets are more highly correlated than they have ever been.

Yields may be settling down.: 

Yields may be settling down. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012

The good news is that the US is de-coupling!: 

The good news is that the US is de-coupling! Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012

The consumer has returned.: 

The consumer has returned. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Historically, retail spending by US consumers accounts for 38% of their income; after a significant decline (associated with the inability to dis -save), it is returning to that median. We interpret this to mean consumers are spending from their income statement rather than their balance sheet; therefore, this trend is durable.

Better loan activity indicates better health for the banking system.: 

Better loan activity indicates better health for the banking system. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012

Exports & durable goods both in uptrend.: 

Exports & durable goods both in uptrend. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012

Consumer credit: 

Consumer credit Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Consumer borrowings are higher (indicating higher confidence), while debt service payments are much lower.

Housing prices: 

Housing prices Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 There remains headline risk, and foreclosure activity will accelerate in 2012. But, we could be nearing a bottom in prices on the second housing dip (the first pull out was artificially introduced by government policy).

What we’re watching closely…: 

What we’re watching closely… Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Even as the US economy begins to look better, there are some data we are closely monitoring as we continue to navigate the European mess. These include longer term items as well as the following shorter-term indications of market fear: Credit spreads TED spread TIPs inflation expectations

What we’re watching closely… Credit spreads.: 

What we’re watching closely… Credit spreads. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 This chart makes us a little nervous as credit spreads as a percent of base rates is high.

What we’re watching closely… TED spread.: 

What we’re watching closely… TED spread. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012

What we’re watching closely… Expected inflation.: 

What we’re watching closely… Expected inflation. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012

What we’re watching closely… Measured inflation.: 

What we’re watching closely… Measured inflation. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 We are watching closely for pressure to increase on prices. This could be a significant turning point.

Where do we go from here?: 

Where do we go from here? Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012 Cornerstone believes that… It is highly unlikely that Europe doesn’t solve its debt / currency crisis. When solved, that will remove much of the fear from the markets. There will be a trade away from US Treasuries as market participants assume additional risk. This will cause interest rates to rise. With strong US fundamentals driving equity returns here. And, international equity returns being driven by flow of funds back into those economies (even as some nations in Europe lapse into recession).

Corporate profits are strong, but be careful when they are too high relative to GDP.: 

Corporate profits are strong, but be careful when they are too high relative to GDP. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012

This remains exceedingly bullish.: 

This remains exceedingly bullish. Copyright 2003-2012, All rights reserved. investwithcornerstone.com 01/10/2012