Opportunities in a Challenging Global Business Environment: Can the World Avoid a Double-Dip?

Opportunities in a Challenging Global Business Environment: Can the World Avoid a Double-Dip? Ross DeVol Chief Research Officer (310) 570 4615 rdevol@milkeninstitute.org www.milkeninstitute.org Presentation For: Guggenheim Investment Summit Santa Monica, CA December 6, 2012

Presentation overview Structural changes in global economy Eurozone and contagion threats China s growth pause ending Japan: disasters and disruptions to growth Latin America cools off U.S. economic conditions World economic outlook summary

Two-speed economic recovery: Real GDP growth, percent 10 8 6 4 2 0-2 -4 Developing economies Advanced economies World -6 1980 1985 1990 1995 2000 2005 2010 Source: International Monetary Fund.

Developing economies are expected to surpass advanced economies in 2013 Share of world GDP, based on purchasing -power-parity (PPP) 65 60 55 50 45 Advanced economies 40 Developing economies 35 30 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 Source: International Monetary Fund.

Brazil, China, India and Russia ascent among the top 15 Ranked GDP in U.S. dollars GDP Rank 2004 2005 2006 2007 2008 2009 2010 2011 2012 1 United States United States United States United States United States United States United States United States United States 2 Euro zone Euro zone Euro zone Euro zone Euro zone Euro zone Euro zone Euro zone Euro zone 3 Japan Japan Japan Japan Japan Japan China China China 4 Germany Germany Germany China China China Japan Japan Japan 5 UK UK China Germany Germany Germany Germany Germany Germany 6 France China UK UK France France France France France 7 China France France France UK UK UK Brazil Brazil 8 Italy Italy Italy Italy Italy Italy Brazil UK UK 9 Spain Canada Canada Spain Russia Brazil Italy Italy Italy 10 Canada Spain Spain Canada Brazil Spain India Russia Russia 11 Mexico Brazil Brazil Brazil Spain Canada Canada India India 12 Korea Mexico Russia Russia Canada India Russia Canada Canada 13 India Korea Korea India India Russia Spain Spain Spain 14 Brazil India Mexico Korea Mexico Australia Australia Australia Australia 15 Australia Russia India Mexico Australia Mexico Mexico Mexico Korea Sources: International Monetary Fund, Milken Institute.

Euro zone: GIIPS yield spreads Over 10-year German bonds 10 year yield (11/30/2012) Greece 16.1 Portugal 7.6 Spain 5.3 Italy 4.5 France 2.1 Germany 1.4 Source: Bloomberg.

Long term interest rates Selected Euro zone nations Percent France Germany Greece Ireland Italy Spain 30 25 20 15 10 5 0 1996 1998 2000 2002 2004 2006 2008 2010 2012 Source: OECD.

Euro area: total bank deposits Year-over-year growth Percent Belgium Ireland Greece Spain France Italy Portugal 40 30 20 10 0-10 -20-30 2008 2009 2010 2011 2012 Sources: ECB

Europe: Gross debt across sectors 1998 and 2010 % of GDP 450 400 350 300 250 200 150 100 50 0 1998 2010 General government debt Household debt Corporate debt Source: World Economic Outlook, International Monetary Fund, April 2012.

Europe is over banked Bank assets as share of GDP Percent 600 500 400 300 2010 2002 200 100 0 Sources: IMF United Kingdom Euro area GIIPS Japan United States

European leader s muddle through approach Sources: Deutsche Bank and Milken Institute

Competitiveness disparities still to be addressed Unit labor costs in Europe 2000-2011 Index (2000=100) 145 140 Ireland Greece 135 130 Spain Italy 125 120 Portugal 115 110 105 Germany 100 95 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: European Central Bank.

Europe enters a double dip Europe: Industrial Production Germany France Italy Source: Oxford Economics.

Exports to the euro zone % of total exports, 2010 Country Share (%) U.K. 50.3 Central and Eastern Europe 48.6 China 14.8 India 14.5 U.S. 13.9 Latin America 10.4 Emerging Asia 9.2 Source: Oxford Economics/IMF.

China: PMIs paint a conflicting picture Manufacturing PMIs 50= expansion/contraction line 60 55 Official PMI 50 45 HSBC PMI 40 35 2006 2007 2008 2009 2010 2011 2012 Sources: NBS, Bloomberg, CLSA.

China s downturn coming to an end? Industrial value-added, retail sales and exports Percent change, year ago 25 Percent change, year ago 60 20 Retail sales (L) 40 15 20 10 5 Exports (R) Industrial value-added (L) 0 2008 2009 2010 2011 2012 0-20 -40 Sources: NBS, China Customs, Milken Institute.

Asian exports slow due to Europe Destination of Asian exports % exports of goods China Philippines Indonesia Malaysia Hong Kong Korea Singapore Thailand Eurozone US 0 2 4 6 8 10 12 14 16 18 Source : Oxford Economics/Haver Analytics.

Japan flirting with recession Japan: Exports and Reuters Tankan survey % balance Reuters Tankan Survey, RHS Export volumes, LHS Source: Oxford Economics.

Japan needs China Japan and China: Export dependence % of total export growth, 2002-2011 60 50 40 30 Half of Japan's rise in exports since 2002 has been to China, while just 6% of China's increase has been exports to Japan 20 10 0 Japanese exports to China Chinese exports to Japan Source : Oxford Economics/Haver Analytics

India s demography Over the next 10 years, India will add over 5 workers for every 1 worker added by China... Addition to working age population 2010-2020 (in millions) India Latin America China U.S. Japan Europe -21-8 11 23 50 136 with the world s largest addition of people to the workforce, it is estimated that over 100 million households will join the middle class Number of Indian households (in millions) % by annual income 1 5 31 64 1 14 3 7 31 34 50 40 26 46 32 15 2000 2008 2020 2030 Wealthy Middle class Aspiring middle class Impoverished Source: Morgan Stanley.

Brazil escapes recession, barely Latin America: Monthly GDP % year 12 3 month moving average 9 Brazil 6 3 0-3 -6 Mexico -9 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Haver Analytics.

Selected equity markets From world peak to present (as of November 30, 2012) % Source: MSCI via Bloomberg.

U.S. overview Jobs and small business-the crux of growth challenge Consumer spending reviving Housing: finally, a bottom? Business investment slows Trade and exposure to euro zone Debt and the fiscal cliff

Weak U.S. jobs recovery compared with previous recoveries Percent change in total nonfarm employment from the start of recession 10 8 6 4 2 0-2 -4-6 -8 2007-09 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 Sources: U.S. Bureau of Labor Statistics, Milken Institute. Months after the start of recession 1990-91 2001 1973-75 1981-82

U.S. households reduce financial debt obligations Debt service payments as a percent of disposable income Percent 12 Mortgage debt 10 8 6 Consumer debt 4 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Sources: Federal Reserve Board, Moody s Analytics.

Auto sales show strong recovery in U.S. Light vehicle sales Millions, SAAR 18 16 14 12 10 8 2006 2007 2008 2009 2010 2011 2012 Sources: Bureau of Economic Analysis, HIS Global Insight.

U.S. home sales pick up Single-family home sales Percent change, year ago 60 40 20 Existing 0-20 -40 New -60 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: National Association of Realtors, Moody s Analytics.

U.S. home prices have bottomed out Median existing single-family home price Percent change, year ago 20 10 0-10 -20 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: National Association of Realtors, Moody s Analytics.

Spending on ICT equipment and software slowing Real U.S. private domestic investment and pers. cons. expend. Percent change, year ago 20 15 10 5 0-5 -10-15 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: Bureau of Economic Analysis, IHS Global Insight.

Nondefense capital goods (excluding aircraft) Value of U.S. manufacturers new orders Percent change, year ago 30 20 10 0-10 -20-30 -40 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: U.S. Census Bureau, IHS Global Insight.

Export growth slows U.S. international trade in goods and services Percent change, year ago 30 20 Imports 10 0 Exports -10-20 -30-40 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: U.S. Census Bureau, IHS Global Insight.

U.S. trade in goods and services Merchandise exports by region, 2011 Source: U.S. Census Bureau. Share of U.S., Value ($ bil.) exports Canada 280.8 19.0% EU 268.6 18.1% Mexico 197.5 13.3% South America 114.5 7.7% China 103.9 7.0% Japan 66.2 4.5% United Kingdom 56.0 3.8% Germany 49.1 3.3% South Korea 43.5 2.9%

Federal government net saving United States US$ billions, SAAR 0-200 -400-600 -800-1000 -1200-1400 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: Bureau of Economic Analysis, IHS Global Insight.

Snapshot of the fiscal cliff Change in budget deficit under current law, fiscal year 2012-2013 Revenues $billion % of GDP End of Bush tax cuts & AMT indexing 221 1.5 End of payroll tax cut 95 0.6 Other expiring tax cuts 65 0.4 Start of Affordable Care Act taxes 18 0.1 Subtotal 399 2.6 Spending Automatic discretionary spending cuts 65 0.4 End of emergency unemp. benefits 26 0.2 Cut to physicians Medicare payments 11 0.1 Subtotal 103 0.7 Other changes in revenues and spending 105 0.7 Total 607 4.0 Effects of automatic stabilizers -47-0.3 Total change 560 3.7 Sources: U.S. Congressional Budget Office.

Summary of fiscal cliff scenarios Tightening in fiscal policy No cliff Full cliff Bungee jump off cliff Partial cliff $95 billion $600 billion $95 billion $300 billion Political backdrop Congress split, no major shift in power Congress split & bitter debate Congress split & bitter debate Either party controls White House and both Houses of Congress Impact on economy GDP: +1.7% GDP: -0.5% GDP: +1.0% GDP: +0.6% Unemp. rate: 8.0% Unemp. rate: 9.1% Unemp. rate:8.3% Unemp. rate: 8.5% Probability 60% 15% 20% 5% Sources: U.S. Congressional Budget Office, Capital Economics, Milken Institute.

Global economic forecast* GDP, year-over-year percent change 2010 2011 2012* 2013* Global (2005 PPP weights) 4.6 3.7 2.7 3.2 Advanced economies** 2.9 1.6 1.4 1.8 U.S. 3.0 1.8 2.1 2.5 Euro zone 1.8 1.6-0.9-0.4 U.K. 2.1 1.0 0.2 1.0 Japan 4.5-0.9 1.4 1.2 Korea 6.2 3.6 2.8 3.8 Canada 3.2 2.5 2.1 2.4 Developing countries** 7.3 6.0 4.5 5.2 China 10.4 9.3 7.5 7.9 India 8.7 7.3 5.3 6.5 Mexico 5.4 3.9 3.5 3.8 Brazil 7.5 2.9 1.4 3.4 Russia 4.0 4.1 3.0 3.3 Source: Milken Institute. * Milken Institute Forecast as of October 25, 2012; ** aggregated using 2005 PPP weights.

Global economic forecast* GDP, year-over-year percent change 2010 2011 2012* 2013* Global (2005 PPP weights) 4.6 3.7 2.7 3.2 Advanced economies** 2.9 1.6 1.4 1.8 U.S. 3.0 1.8 2.1 2.5 Euro zone 1.8 1.6-0.9-0.4 U.K. 2.1 1.0 0.2 1.0 Japan 4.5-0.9 1.4 1.2 Korea 6.2 3.6 2.8 3.8 Canada 3.2 2.5 2.1 2.4 Developing countries** 7.3 6.0 4.5 5.2 China 10.4 9.3 7.5 7.9 India 8.7 7.3 5.3 6.5 Mexico 5.4 3.9 3.5 3.8 Brazil 7.5 2.9 1.4 3.4 Russia 4.0 4.1 3.0 3.3 Source: Milken Institute. * Milken Institute Forecast as of October 25, 2012; ** aggregated using 2005 PPP weights.

Growth returns over the next decade Economic growth prospects: 2011-2021 Annual growth, US$ basis Emerging Asia Sub Saharan Africa Middle East & North Africa Latin America US Eurozone Source : Oxford Economics. 0 1 2 3 4 5 6 7

Global middle class: Present and future Middle class consumer spending Rest of the world 26% 2009 EU 30% Rest of the world 20% 2030 EU 14% U.S. 7% Other Asia 9% Other Asia 14% Japan 4% India 2% China 4% Japan 8% U.S. 21% India 23% China 18% Middle class: all those living in households with daily per capita incomes between $10 and $100, adjusted for local purchasing power. Source: Morgan Stanley Smith Barney.