Mike's Whiteboard Wisdom

Michael J. Schmitz Vice President - Investments Chief Operating Officer Portfolio Manager [email protected] ECONOMIC EVALUATION & INTELLIGENT MARKET INSIGHTS VOLUME II, ISSUE 5 | MAY 2012 Mike’s Whiteboard Wisdom MAYDAY...MAYDAY...MAYDAY According to Wikipedia, Mayday is an emergency procedure word used internationally as a distress signal in voice procedure radio communications. It derives from the French venez m'aider, meaning "come help me". I struggled to find a more appropriate term to describe the current situation in Europe...and specifically Greece’s current cry for help. Greece is known for both corruption and tax evasion. Labor productivity is low and the IN THIS ISSUE government engaged in wild deficit spending (not unlike the U.S.). Greece needs serious help, and their “mayday” is being felt all over the globe. However, despite the obvious HIGHLIGHTS: self-inflicted problems, their cry for help at this juncture is probably warranted since austerity alone isn’t likely to “fix” their problems. • Mayday, Mayday, Mayday - Greece needs help... ► 1 Greece’s troubles can also be blamed, in part, on wealthier Eurozone countries, who convinced the world that a single currency could work without a single, centralized govern- • May in review... ► 4 ment. Eurozone policymakers have compounded the problem by insisting that irrespon- sible behavior was the sole cause of Greece’s current travails. Attempting to force strict • “Playing hooky” for 27 weeks austerity measures on the Greek people (clearly as both punishment and the preferred or more... ► 6 solution) may actually exacerbate the problems in the short-term, cause more anger and misery for the Greek people, and do little to solve the important underlying issues. • U.S. production slowing... ► 7 After successfully arranging a massive debt restructure, Greece now faces a political • Breaking up with commodities challenge. No party won an absolute majority of seats in the May 6 election, which re- after a “spring fling”…. ► 11 sulted in a formal decree to dissolve the newly elected parliament and call for new elections on June 17. Meanwhile, the public hostility toward austerity measures as stipulated • Mid-year reality check... ► 13 by the terms of Greece’s bailout arrangements with the EU and IMF has elevated concerns that the country may be headed for an exit from the euro. QUICK LOOK INSIDE: Despite all the talk about the Eurozone’s efforts to try and stop the contagion, much of the world seems to be infected with this “Euro-virus”. Fear often spreads like disease Greece Needs More Help 1 and there were certainly no “May Flowers” for the global capital markets this month. Market Snapshot 2 The Euro-virus brought many of the global financial markets to their knees. For many global indices, equity market returns for the first 4 months of 2012 evaporated as con- Summary Table 3 cerns about Spain’s banking sector intensified, there was a change of government lead- ership in France, and elevated worries over Greece’s continued political turmoil in- Month in Review 4 creased the debates over how to handle the Eurozone’s debt and fiscal problems. To compound the problems overseas, lackluster economic data in the U.S. and a slowdown Housing 5 in China also dampened the global growth outlook. Labor Market 6 We continue to monitor developments in the Eurozone closely and our outlook remains cautious. As we look into the future, unfortunately without the aid of any crystal ball, we Consumer/Retail 7 will be monitoring Greece’s political situation closely since it just might dictate austerity Inflation/Interest Rates 8 policies and, potentially, their continued participation in the euro. The Eurozone growth outlook is pretty grim, the need to recapitalize the Spanish banking system is the newest Manufacturing 9 threat, fiscal deficits remain a problem, continued austerity debates are tiring politicians and voting citizens, and the shake-up in France’s government may bring fresh issues to Emerging Markets 10 the table as French President François Hollande begins negotiations with German Chan- Commodities/U.S. Indices 11 cellor Angela Merkel.

Economic Indicators 12 Items of Interest 13

Conclusion 14 SCP Snapshot 15

Important Disclosures 16

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 1 May 2012 | Mike’s Whiteboard Wisdom MARKET SNAPSHOT

Key Rates Current Year Federal Funds Rate Unemployment Rate Monthly Data Monthly Data Data To Date 8.00 11.00 30 - Year Bond 2.89% 0.0% 10.00 6.00 9.00 8.00 10 - Year Note 1.88% 0.0% 7.00 4.00 6.00 2 - Year Note 0.24% 0.0% 5.00 2.00 4.00 Fed Funds Rate 0-0.25% 0.0% 3.00 0.00 2.00 Prime 3.25% 0.0% LIBOR- 3 Mos. 0.55% (0.0%) 15 Year Mortgage- Fixed 3.15% (0.3%) Source: Bureau of Labor Statistics Source: Bureau of Labor Statistics Monthly Change In US Non-Farm Payrolls Consumer Sentiment 30 Year Mortgage- Fixed 3.84% (0.2%) Seasonally A djusted Not Seasonally A djusted 500,000 120.00 Jumbo Mortgages ($417,000+) 4.40% (0.4%) 400,000 300,000 110.00 5/1 ARM (Adjustable Rate) 2.95% (0.1%) 200,000 100.00 100,000 90.00 0 80.00 New Car Loan (48 Month) 4.35% 0.5% -100,000 70.00 -200,000 Home Equity Loan ($30,000) 4.69% (0.1%) -300,000 60.00 -400,000 50.00 -500,000 40.00 Currencies End of Wk. Year -600,000 5/31/2012 To Date -700,000 -800,000 Euro (€) vs. Dollar ($) $1.24 (4.3%) Source: Bureau of Labor Statistics Source: University of Michigan

Pound (₤) vs. Dollar ($) $1.54 (0.1%) Consumer Price Index (12 Month % Change) Producer Price Index (12 Month % Change) Not Seasonally A djusted Not Seasonally Adjusted Dollar ($) vs. Yuan (Y) 6.37 0.3% 6.0 10.0 Dollar ($) vs. Yen (¥) 78.32 0.7% 5.0 8.0 6.0 4.0 Indices / Benchmarks End of Wk. Year 4.0 3.0 2.0 5/31/2012 To Date 2.0 0.0 Dow Jones 12,393 1.4% 1.0 -2.0 0.0 -4.0 S&P 500 1,310 4.1% -1.0 -6.0 -2.0 -8.0 NASDAQ 2,827 8.5% -3.0 -10.0

Russell 2000 762 2.8% Source: Bureau of Labor Statistics Source: Bureau of Labor Statistics

MSCI Emerging Markets 906 (1.1%) Industrial Production Capacity Utilization Seasonally A djusted Seasonally A djusted

Inflation Current Year 105.00 85.00

Data To Date 100.00 80.00 GDP Growth (Last reported Q) 1.9% 95.00 75.00 Consumer Price Index (CPI) (0.3%) 90.00 70.00 85.00 Producer Price Index (PPI) (0.1%) 80.00 65.00 Oil Price ($ per barrel) $86.53 (12.4%) Natural Gas Price ($/MMBtu) $2.39 (32.3%) Gold Price ($/troy oz.) $1,560.43 (0.2%) Source: Federal Reserve Source: Federal Reserve Unemployment Insurance (Initial Weekly Jobless Claims) Investor Sentiment Current Prior Seasonally A djusted 700,000 Data Month 600,000 Consumer Sentiment 79.3 76.4 500,000 400,000 Consumer Confidence 64.9 69.2 300,000 Total Put - to - Call 1.08 200,000 100,000 Volatility Index (VIX) 24.06 0

Source: Federal Reserve Real GDP (Quarterly Percent Change) S easonally A justed A nnual R ate

8.0 6.0 4.0 2.0 0.0 Sources: amgdata.com, bloomberg.com, hoovers.com, onada.com, Bankrate.com, WSJ, ‐2.0 Yahoo Finance, Federal Housing and Finance Board, B ureau of Labor St at ist ics and various ‐4.0 online data retrieval websites ‐6.0 VIX values > 30 = more volatility as a result of investor fear or uncertainty, ‐8.0

VIX values < 20 = less stressful, even complacent, times in the markets Indexes cannot be invest ed in direct ly, are unmanaged and do not incur management f ees, cost s and expenses. Past perf ormance is not a guarant ee of f ut ure result s. Source: Bureau of Economic Analysis DISCOVER | DEFINE | DEVELOP | DESIGN | CONSTRUCT | MONITOR | EVALUATE

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 2 May 2012 | Mike’s Whiteboard Wisdom

SUMMARY

The table below is meant to be a quick illustration which confirms some of our thoughts on the broader economy and current outlook. Emerging Markets Despite the longer-term demographics and fundamentals, EMs will likely remain volatile due to problems in the U.S. (growth), China (inflation) and sovereign debt crises in Europe. Central banks in many EM’s have eased monetary policy, reversing inflation-fighting/tightening policies which even- tually curbed growth. We still believe in this sector’s long-term strength due to demographics (large emerging consumer bases), stronger govern- Positive ance and “relatively” solid balance sheets. U.S. Inflation Inflationary pressures moderated significantly in Q1 2012 and remain in the Fed’s “comfort zone”. Our near-term inflation expectations are very low. Interest Rates Borrowing costs remain at historically low levels and, due to economic conditions, the Fed has indicated it is highly unlikely to tighten until late 2014. The yield curve should steepen as the economy grows. U.S. Corporate Earn- Cash balances are at historic levels ($2 trillion-plus) and balance sheets re- ings main very strong. The corporate sector is as strong as it has been in over 10 years, but earnings should moderate and top-line growth will be king. Consumer / Retail Consumer sentiment/confidence has been mixed, but other indicators are showing a consumer pull-back. The recent explosion in credit came to an end consumer strength may have stalled due to growing concerns about the Eurozone and the hiccups in the domestic economy. Manufacturing Manufacturing data was mixed. Industrial production was up 1.1%, and manufacturers Neutral in the Fed's New York region reported a strong rebound from the previous month. However, the Philly Fed's manufacturing survey turned negative. Commodities Commodities, showing their volatility, plummeted in May. Macroeconomic uncertainty and financial deleveraging pulled price levels below those justified by fundamentals and they remain a hedge against an inflationary environment and are generally negatively correlated with equity returns. Global Growth Europe is likely to face even more serious headwinds as it faces a recession and serious country-specific issues. Emerging markets growth is moderat- ing to more sustainable levels. The U.S. remains in a “slow” recovery. Economic Growth / Gross domestic product (GDP) was revised downward to 1.9% in Q1 2012. Indicators / Trade Indicators are showing economic expansion, but at a slower rate than Q4 Balance 2011 and threatening the continued recovery in 2012. Housing New homes, existing homes, housing starts and construction spending were all slightly down as of the most recent data. There are signs of life sprinkled throughout pockets in the data, but is still bouncing around the trough. Labor Market The overall unemployment rate ticked up to 8.2%. Once again, ADP, private sector and non-farm payrolls all missed expectations, while new claims for unemployment benefits decreased to 377,000, well above 350,000.

Europe Sovereign Europe remains a major risk. While it appears that a Greek exit is not immi- Negative Debt nent in the near-term, the underlying fundamental problems remain. Fiscal austerity is proving painfully elusive for Eurozone policymakers. The need to recapitalize the Spanish banking system is the new threat. U.S. Political Land- Political dysfunction and polarization will likely continue to feed market scape volatility. Election year politics are likely to exacerbate the issues even as the U.S. economy is showing signs of a more healthy recovery.

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 3 May 2012 | Mike’s Whiteboard Wisdom

THE MONTH IN REVIEW - MAY 2012 The Month in Review

► Popular frustration with eurozone austerity programs began hitting home in Europe with Socialist François Hollande's election as France's president and the rise of anti-austerity political parties in Greece. After those parties failed to form a coali- tion government, new elections were scheduled for June 17 as concern mounted that an anti-austerity government might default or try to renegotiate the terms of Greece's bailout. Eurozone leaders continued to insist they want to avoid a "Grexit" and some began raising the possibility of a jointly backed "eurobond." However, the uncertainty plus currency flows out of the country's banks led to increased worries about the impact of a default or exit on other countries .

► As Spanish banks received another credit rating downgrade, the government in Madrid was hit with new bailout demands from Spain's fourth-largest bank as well as one of its regional governments. Anxiety about the banks' stability and the government's resources to help them pushed the yield on the country's benchmark 10-year bond from 5.8% to 6.6% over the course of the month.

► Unemployment rose to 8.2%, according to the Bureau of Labor Statistics' May report. However, that was not necessarily good news, as the drop was largely the result of people leaving the workforce. The economy created only 69,000 new nonfarm payroll jobs; that's substantially lower than the 115,000 jobs added the previous month or the 143,000 monthly average between December and February.

► U.S. economic growth was even slower during the first quarter of 2012 than the Bureau of Economic Analysis's 2.2% initial estimate. The revised gross domestic product figure was 1.9%, substantially lower than the previous quarter's 3%. Consumer spending picked up 2.9% in Q1, but business spending was off.

► Home sales statistics were more encouraging than in recent months. Fueled by record low mortgage rates--lender Freddie Mac said the rate for a 30-year fixed loan hit 3.75%--sales of both new and existing homes jumped more than 3.3% in April, according to the Commerce Department and the National Association of Realtors®.

► Status changes: After one of the biggest tech IPOs on record, Facebook's stock price took a nosedive, hurt by both a massive trading snafu the day of the offering and the Securities and Exchange Commission's subsequent announcement that it would look into whether the offering's underwriters warned key clients (but not the public) at the last minute about the company's financial challenges. Meanwhile, J.P. Morgan Chase said trading in credit derivatives had cost the bank an estimated $2 billion or more, and Hewlett-Packard announced it would cut 27,000 jobs over the next two years to compete more effectively in a changing tech environment.

► Manufacturing data continued to be somewhat mixed. The Commerce Department said durable goods orders increased for the second time in three months, industrial production was up 1.1%, and manufacturers in the Fed's New York region reported a strong rebound from the previous month. However, the Philly Fed's manufacturing survey turned negative for the first time in eight months.

► Inflation remained moderate as declines in energy costs helped offset increases in other consumer prices, leaving the Con- sumer Price Index flat for the month and at 2.3% for the past year. Meanwhile, the Bureau of Labor Statistics said wholesale prices fell 0.2%, putting the year-over-year wholesale inflation rate at 1.9%.

► Both consumer spending and personal incomes rose, according to the Bureau of Economic Analysis, while the Commerce Department said retail sales were up 0.1% for the month and 6.4% from the same time last year..

Sources: All information, including the actual text, on this page, was provided by Broadridge Investor Communication Solutions, Inc. and is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness.. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. Equities data reflects price changes, not total return. Data sources for non-equities performance: U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold, NY close); Oanda/FX Street (currency exchange rates).

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 4 May 2012 | Mike’s Whiteboard Wisdom

HOUSING – Current Outlook – Negative

There are still signs of life in the new home sales sector, housing data are likely past recent seasonality distortions and the numbers are on a modest uptrend. but they're not yet translating into a true spring surge. New home sales came in at a 343,000 unit annual rate in April 2012. This increase slightly, more than analyst expectations, was echoed by upward revisions added to 9 of the last 13 months including March (up 4,000 to 332,000) and February (up 5,000 to 358,000). This data is reflected in the strength shown from the nation's home builders. The supply of homes is down to a recovery low of 5.1 months in April 2012.

Housing starts rebounded in April (+2.6%) to 717,000 units, and the yearly unit pace was just shy of thirty percent at +29.9% Y/Y. Housing permits, which showed weakness from homebuilders, declined -7.0% in April 2012, following a +8.8% increase in March. The latest figure of 715,000 units came in well below consensus estimates of 725,000, but were still offset by March’s surge. Existing home sales increased +3.4% (M/M) to 4.62 million units in April 2012 after March 2012’s revised -2.8% dip. Interestingly, supply on the market at the current sales rate increased to 6.6 months, while the median price increased +7.6%.

Construction spending posted a small increase (+0.3%) in April 2012, on the heels of an upwardly revised (+0.3%) in March 2012. It was estimated at a seasonally adjusted annual rate of $820.7 billion in April 2012, when compared to the revised March 2012 estimate of $818.18 billion. On a year-over-year basis, overall construction outlays were up +6.8% above the April 2011 estimate of $768.2 billion. Construction is showing modest and gradual improvement, and, although the rate is slow, it’s much better than a decline. The housing sector continues to remain under pressure from the supply of unsold homes and low prices, but it seems to be on a modest uptrend as well. Typically, when there is an abundance of existing homes selling heavy discounts, homebuilders have little incentive to start construction of new homes. During the first 4 months of 2012, construction spending amounted to $238.5 billion, 7.3% above the $222.2 billion for the same period in 2011.

Data from the Mortgage Bankers Association (MBA) showed that mortgage applications for home purchases increased +1.3% during the June 1 week. Refinancing applications also increased +2.0%.

Lender Processing Services (LPS) a leading provider of mortgage performance data and analytics, showed a 7.12% home loan delinquency rate and one of the lowest levels since August 2008, but still 2.0x historical averages. Foreclosures are 4.14% (8.0x historical/ pre-crisis averages) and still near historic highs. 7.37% are seriously delinquent (90+ days) or in foreclosure.

Key results from LPS' latest Mortgage Monitor report (04/30/2012) include:

► Total U.S. loan delinquency rate: 7.12%

► Total U.S. foreclosure inventory rate: 4.14%

Key Data Points and Sources:

► Housing Starts (U.S. Census Bureau and the Department of Housing and Urban Development): April 2012 was 717,000 units (+2.6% M/M)

► Housing Permits U.S. Census Bureau and the Department of Housing and Urban Development): April 2012 was 715,000 units (-7.0% M/M)

► Existing Homes Sales (The National Association of Realtors): Single-Family (M/M): April 2012 seasonally adjusted 4.62MM units (+3.4% M/M)

► New Home Sales (U.S. Bureau of the Census, U.S. Commerce Department and the U.S. Department of Housing and Urban Development): April 2012 new homes sales seasonally adjusted 343,000 units (+4.6% M/M)

► Construction Spending (The U.S. Census Bureau of the Department of Commerce): April 2012 seasonally adjusted annual rate of $820.7 billion (+0.3% M/M)

► MBA Purchase Applications (Mortgage Bankers Association): Purchase Index Data for June 1, 2012: +1.3% (W/W)

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 5 May 2012 | Mike’s Whiteboard Wisdom

EMPLOYMENT / LABOR MARKET – Current Outlook – Negative

Employment growth has been slow, and May was no surprise. The ADP report for May 2012 underperformed expectations at +133,000 right after missing expectations for job growth in April (revised to +113,000) and on the heels of blowing away expectations when the private sector added a revised +292,000 jobs back in December 2011. U.S. corporations continue to sit on record piles of cash ($2 trillion-plus), but remain hesitant to hire jobseekers back into the workforce.

According to the Bureau of Labor Statistics, the May U-6, the most comprehensive measure of unemployment (which includes under- employed), was 14.8% of the labor force (seasonally adjusted). The average (mean) duration of unemployment was approximately 39.7 weeks (median was 19.4) and the unemployment rate was 24.6% for 16 to 19-yearolds. The U.S. still has 12.7 million unemployed and about 5.4 million (42.8%) have been out of work for at least 6 months (long-term unemployed - 27 weeks or more).

The unemployment rate was little changed 8.2%. Non-farm payroll jobs were up +69,000, but significantly missed economist expectations of +150,000. May’s dip follows a revised +77,000 rise in April (originally +115,000) and a revised +143,000 increase in March (previously +154,000). Revisions for April and March 2012 were down net -49,000. Private nonfarm payrolls were also disappointing gaining +82,000 in May following a +87,000 increase in April.

The number of persons employed part-time for economic reasons (sometimes referred to as involuntary part-time workers) increased slightly to 8.1 million in May 2012 These individuals were working part time because their hours had been cut back or because they were unable to find a full-time job.

About 2.4 million persons were marginally attached to the labor force in April 2012. These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey for reasons such as school attendance or family responsibilities. Among the marginally attached, there were 830,000 discouraged workers in April 2012. Discouraged workers are persons not currently looking for work because they believe no jobs are available for them. The remaining 1.6 million persons marginally attached to the labor force in May had not searched for work in the 4 weeks preceding the survey for reasons such as school attendance or family responsibilities.

Overall, the labor market is slowing sharply. Job creation wasn't as robust as expected in May 2012, and this latest employment report is evidence that the recovery in the U.S. remains challenged. The numbers clearly indicate a hiring halt. Growth is not strong enough to make a meaningful dent in unemployment and the U.S. still desperately needs a sustained period of job growth to remain on solid economic footing.

Key Data Points and Sources:

► Employment Situation (U.S. Bureau of Labor Statistics):

• Unemployment Rate: 8.2% / 12.7 million people (May)

• Nonfarm Payrolls (M/M): +69,000 (May)

• Private Payrolls (M/M): +82,000 (May)

• Average Hourly Earnings: $23.41 / +$0.03 (May)

► ADP Employment Report (ADP): Private payrolls rose +133,000 in May 2012 versus a revised +113,000 rise in April 2012. The ADP employment report can help improve the payroll forecast by providing information in advance of the employment situation report.

► Challenger Job Cut Report (Challenger, Grey & Christmas, Inc.): Challenger's count of layoff announcements were 61,887 in May 2012 vs. 40,559 in April 2012 and 37,135 in May 2011. This report is basically a rehash of the weekly jobless claims report but provides additional insight into where layoffs are occurring. The report includes industry and state-level detail that is not available with weekly jobless claims data. Since they are announcements, the report does not distinguish between layoffs scheduled for the short-term or the long term, or whether job cuts are handled through attrition or actual layoffs. Therefore it needs to be analyzed with caution.

► Labor Department Unemployment Benefits (U.S. Bureau of Labor Statistics): In the week ending June 2, the advance figure for seasonally adjusted initial claims was 377,000, a decrease of 12,000 from the previous week’s revised figure of 389,000. The 4-week moving average was 377,750, an increase of 1,750 from the previous week’s revised average of 376,000 from the previous week's revised average of 382,750. Any 4-week moving average in danger of breaching the 400,000 mark makes it difficult to believe in sustained recovery in the U.S. The rate needs to drop below the 350,000 mark for a prolonged period before job creation becomes meaningful and sustainable.

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 6 May 2012 | Mike’s Whiteboard Wisdom

CONSUMER / CONSUMER SPENDING / RETAIL – Current Outlook – Neutral

The mood among U.S. consumers steadily improved since Q4 2011, but that trend may have stalled due to growing concerns about the Eurozone and the hiccups in the domestic economy. The more pessimistic attitude they exhibited for the middle part of 2011 was a hurdle for the economy and retailers, and any future pessimism will certainly stymie this recovery. Consumer credit, an indication of consumer strength, skyrocketed in November 2011 ($20.4 billion - there hadn’t been an increase in consumer credit in the $20 billion range past 10 years) and then remained very strong for the next few months and posted another huge spike to $21.4 billion. However, April pulled back to a weaker +6.3 billion. For the time being, the consumer appears to be pulling back from taking on additional debt outside of student loans.

Consumer confidence, after being essentially flat, was down to 64.9 and is no longer testing recovery highs. February 2012 was the best reading since early 2011, but still slightly off the recession high of 72.0 in February 2011. Of the report's roughly 3,000 initial sam- ple, those saying jobs are currently “hard to get” was up and assessment of the present situation was a steep decline. The index now has a long way to climb toward the 80’s (where optimism is greater than pessimism).

Overall retail sales in May 2012 were down as expected (-0.2%) after a +0.7% rise in March 2012 and a flat April 2012. Sales, excluding autos and gasoline, were also negative at -0.2%. ICSC-Goldman's same-store sales index (roughly 10% of all retail sales) was trending downward at -0.5% W/W in the May 26 week and up +0.6% to +2.9% for the Y/Y pace. Total motor vehicle sales, which make-up just less than 20% of total retail sales, were down -4.0% to $13.8 million and domestic sales (U.S.) were down to $10.6 million in May 2012.

In contrast to the consumer confidence index, Reuter's/University of Michigan's consumer sentiment index rose to a recovery high of 79.3 (over +3.0 points since January 2012), led by the current conditions (87.2) and expectations component which is at 74.3. Con- sumer expectations are improving at the same time that their assessment of current conditions improving. This optimism was due, in part, to the decline in gas prices which offsets troubles/worries elsewhere.

Consumer credit dramatically decreased to +6.5 billion from a downwardly revised +12.4 billion in March 2012. Consumer credit has been surging the last six months driven by non-revolving credit, credit in large part that's used to fund vehicle purchases and student loans. Student loans were the primary driver of this increase. The past 6 months (Q4 2011 and Q1 2012) indicated a significant turn- around in the consumer's willingness to take on debt, but the latest few months are certainly reflecting a more cautious consumer.

Key Data Points and Sources:

► Consumer Confidence (The Conference Board): The May 2012 reading was down to 64.9. Consumer spending drives two-thirds of the economy and if the consumer is not confident, the consumer will not be willing to spend. Confidence im- pacts consumer spending which affects economic growth. For stocks, strong economic growth can translate to healthy corporate profits and higher stock prices. Retail sales often moves in tandem with consumer optimism.

► Consumer Sentiment Index (Reuters/University of Michigan): The May 2012 reading increased to 79.3. 500 households are questioned each month on their financial conditions and attitudes about the economy. Consumer sentiment is directly related to the strength of consumer spending.

► Consumer Credit (Federal Reserve Board of Governors): Up +$6.5 billion in April 2012. Growth in consumer credit can hold positive or negative implications for the economy and markets. Economic activity is stimulated when consumers borrow to make major purchases. However, if consumers take on too much debt relative to their income levels (borrow outside their means), they may have to pay off old debts before spending on new goods or services. Inevitably, a curb in spending on new goods and services stymies economic growth.

► Personal Income and Outlays (Bureau of Economic Analysis, U.S. Department of Commerce): Personal Income: +0.2% M/M in April 2012. Consumer Spending: +0.3% M/M in April 2012. Income is the major determinant of spending as U.S. consumers spend roughly 95 cents of each new dollar. Consumer spending accounts directly for more than two-thirds of overall economic activity and indirectly influences capital spending, inventory investment and imports.

► Retail Sales (Bureau of Economic Analysis, U.S. Department of Commerce): Up -0.2% in May 2012 (-0.4% - less autos). Retail sales are a major indicator of consumer spending trends because they account for nearly one-half of total consumer spending and approximately one-third of aggregate economic activity.

► ISCS - Goldman Store Sales (International Council of Shopping Centers & Goldman Sachs ): Up -0.5% W/W and +2.9% Y/Y for the May 26, 2012 week. Chain/Retail store sales are an indicator of retail sales (correspond with roughly 10% of retail sales) and consumer spending trends.

► Motor Vehicle Sales (Autodata and Auto Manufacturers): Total sales were flat -4.0 % M/M (+10.6 million) in May 2012. Motor vehicle sales are an important element of consumer spending and make-up close to 20% of total retail sales. Many market players watch this closely to get a handle on the direction of the economy. Motor vehicle sales are good indicators of trends in consumer spending and often are considered a leading indicator at business cycle turning points. DISCOVER | DEFINE | DEVELOP | DESIGN | CONSTRUCT | MONITOR | EVALUATE

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 7 May 2012 | Mike’s Whiteboard Wisdom

INFLATION – Current Outlook – Positive

Inflationary pressures turned negative at the headline level while holding steady at the core level in May 2012. Given the recent data, and with energy prices cooperating, headline numbers are headed toward the Fed's inflation goal of 2%. Consequently our near-term inflation expectations still remain low. The PPI was subdued, the last few core CPI readings have been moderate/slowing and businesses are indicating that input cost pressures are abating. Given the delicate economic footing and continued threats from Europe, we think it is unlikely the Fed will do anything for well over a year (recently confirmed by FMOC statement in August saying they probably won’t touch rates until 2014).

In May 2012, overall CPI only fell to -0.3%, following a +0.0% and essentially flat April 2012. May’s pace, however, was just a tad lower in line consensus expectations for a -0.2% decline to -0.2%. CPI (excluding food and energy), the CPI was a +0.2% increase right in line with analysts expectations of a +0.2% rise. Bottom line: consumers are paying less at the gas pump, freeing up some money to spend elsewhere

PPI inflation in April 2012 declined at headline level. Meanwhile, the core rate accelerated slightly. The PPI was down -0.1% in May 2012 (due primarily to energy cost) after a -0.2% April 2012. The core PPI, however, posted a +0.2% rise, following a gain of +0.2% in April 2012 and directly in line with analysts expectations for a +0.2% increase.

Key Data Points and Sources:

► Consumer Price Index - CPI (Bureau of Labor Statistics, U.S. Department of Labor): Negative -0.3% M/M and +1.7% Y/ Y in May 2012. The benchmark inflation guide for the U.S. economy and the most widely followed monthly indicator of inflation. It uses a "basket of goods" approach that aims to compare a consistent base of products from year to year, focusing on products that are bought and used by consumers on a daily basis. The CPI is considered a cost-of-living measure since it is used to adjust contracts of all types that are tied to inflation.

► Producer Price Index – PPI (Bureau of Labor Statistics, U.S. Department of Labor): Negative -0.1% M/M and +0.8% Y/ Y in May 2012. An inflationary indicator used to evaluate wholesale price levels in the economy. It measures monthly or yearly changes in the producer's price of consumer goods and capital equipment before they are passed along to the consumer. The producer price index for finished goods is a major indicator of commodity prices in the manufacturing sector. These prices are more sensitive to supply and demand pressures than the more comprehensive CPI.

INTEREST RATES – Current Outlook – Positive The Fed is still squarely in the middle of a debate about the direction of the economy. "The staff's forecast for inflation over the projection period was just a bit above the forecast prepared for the March FOMC meeting, reflecting somewhat higher-than-expected data on core consumer prices and a slightly narrower margin of economic slack than in the March forecast. However, with the pass-through of the recent run-up in crude oil prices into consumer energy prices seen as nearly complete, oil prices expected to edge lower from current levels, substantial resource slack persisting over the projection period, and stable long-run inflation expectations, the staff continued to forecast that inflation would be subdued through 2014. There are still major risks from abroad (Fed still sees headwinds from Europe), and possibly fiscal contractionary policy (fiscal cliff) in coming quarters.” - FMOC Minutes (April 24-25 Meeting) Released 5/16

More recent economic data have been more negative and monetary policy currently is still extremely loose. The loose monetary policy is intended to encourage businesses to make plans based on low interest rates because the risks inherent in a slow growth scenario are still elevated. There is a good chance the Fed will extend the “Operation Twist” program meant to drive down long-term interest rates and may need to prepare to take further action, if needed, given the heightened worry about the economy's performance The Fed continues to state that exceptionally low policy rates are likely through 2014. For now, the condition of a worsening economy is not forecasted, meaning QE3/”quantitative easing”/bond buying is not going to be implemented...yet.

Key Data Points and Sources:

► 30 Year Bond: 2.89%

► 10 Year Note: 1.88%

► 2 Year Note: 0.24%

► Fed Funds Rate: 0.00% - 0.25%

► Prime: 3.25%

► LIBOR - 3 Month: 0.55%

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 8 May 2012 | Mike’s Whiteboard Wisdom

EMERGING MARKETS – Current Outlook – Positive

In mid-2011, Eurozone problems resulted in a mass sell-off in many emerging markets as investors switched into intense “risk-reduction” mode. While emerging economies face a wide range of battles (including the travails of the developed world), they remain some of the fastest growing markets on the planet and anticipated future GDP growth remains a compelling factor in remaining invested in EMs. Investors grew more willing to take on risk in Q3, thanks, in part, to an improving U.S. economy and subsiding fears over the Eurozone crises (which have now resurfaced). Despite slowing growth in many emerging markets as policymakers battled inflation, the risk of overheating has subsided for the time being. EM policymakers remain flexible and continue to address the challenges their countries face. However, the past 3 months have witnessed subdued to poor equity market performance as renewed concerns over the European fiscal crisis dulled the outlook for exports from some of the leading emerging economies. The moderate correction in energy and other commodity prices contributed to the more pessimism toward economic growth in resource exporting countries.

Key Countries / Regions:

► China: China’s 1Q2012 GDP growth moderated to 8.1% Y/Y (Goldman forecast: 8.5% Y/Y, Bloomberg consensus: 8.4% Y/Y, Reuters consensus: 8.3% Y/Y), from 8.9% Y/Y in 4Q2011. March industrial production (IP) growth rose to 11.9% Y/Y (our forecast: 11.9% Y/Y, Bloomberg consensus: 11.6% Y/Y, Reuters consensus: 11.5% Y/Y), from 11.4% Y/Y in January-February (Asia-MAP score: 4 [4, 1]). Nominal retail sales growth rose to 15.2% Y/Y in March (Goldman forecast: 15.4% Y/Y, Bloomberg consensus: 15.1% Y/Y, Reuters consensus: 15.0%), from 14.7% Y/Y in January-February. January-March fixed asset investment (FAI) growth fell to 20.9% Y/Y (our forecast: 22.2% Y/Y, Bloomberg consensus: 21.0% Y/Y, Reuters consensus: 20.8% Y/Y), from 21.5% Y/Y in the January-February period. The implied growth in March alone is 20.4% Y/Y. Goldman believes the reason for the disappointing GDP data despite strong policy loosening is the loosening came in rather late in the quarter and growth in the first two months was weak. While March does have a higher share compared with January or February (but not higher than January AND February), and it had a strong sequential acceleration in IP growth (January-February s.a. annual growth was around 10%, March was around 20%, vs. trend level of around 15%), it was not sufficient to save the quarterly number, in their view. The good news is the loosening impact will likely be better reflected on activity growth data going forward as there is a lag between the monetary loosening and activity growth. More importantly, the government clearly has been and is still concerned about the slowdown in activity growth and will likely keep policy relative loose in the next quarter at least. As a result of this and the expected firm external demand growth, they expect sequential GDP growth to show meaningful improvements from 2Q2012 onwards. As the base from last year becomes low, it is most likely that 1Q2012 Y/Y GDP is the trough in the year. Goldman is maintaining its 8.6% annual GDP growth forecast and recognize there are modestly more risks on the downside than upside.

► India: In India, the RBI released its FY13 GDP growth forecast at 7.3%; and WPI inflation forecast at 6.5%, generally in line with consensus expectations. Goldman’s FY13 GDP growth forecast is at 7.2%. On inflation, they think that core inflation will remain anchored around 5%. The RBI mentioned that “upside risks to inflation persist which inherently limit the space for further reduction in policy rates”. The RBI has clearly shifted its focus to growth, but is still not comfortable with headline inflation numbers. By not adopting an explicitly dovish tone in the statement, the RBI has bought itself some degree of freedom in case there were to be a spike in headline inflation driven by food and oil prices. The RBI has chosen to sound hawkish but act dovish, given the sharp slowdown in growth, and yet elevated inflationary expectations. Gold- man does not think the language prohibits the RBI from cutting rates again if the growth-inflation dynamics so warrant.

► Brazil: Goldman believes that Brazil should also continue to expand faster, led by strong domestic demand. Real GDP declined -0.23% M/M s.a. in February (broadly in line with the market consensus). The 3-mma of sequential non-annualized quarterly real GDP growth moderated to 0.87% from 1.05% in January (still up from 0.14% in December). The real business cycle likely bottomed out during 3Q2011 and now looks clearly to be recovering. Goldman believes the outlook for domestic demand is positive given ongoing central bank easing, solid credit flows (backed by the partial reversal of some macro-prudential measures), a very tight labor market, large double-digit increase in the minimum wage, targeted fiscal incentives to consumption, and a strengthening consumer.

► Russia: In Russia, Goldman expects a year of two halves. Growth should continue to disappoint in 2011H1 but then accelerate in 2011H2, driven by domestic demand and in particular strengthening investment (which has been muted in recent years). In their view, the recent fiscal loosening coupled with pressure on the CBR not to tighten, puts the risk to Goldman’s above-consensus forecasts for final domestic demand of 6.3% Y/Y in 2012 and below-consensus forecast of 6.2% inflation to the upside. They expect annual growth to accelerate from 5.3% in 2011 to 5.6% in 2012.

► South Africa: Goldman reported that growth in Q2 and Q3 of 2011 was particularly weak, providing a low ‘base’ from which growth (particularly in manufacturing) reaccelerated strongly, despite weaker growth in the Euro area and deteriorating external demand in Q4. By our estimation, Q4 growth was around the trend rate (its estimates range from 3.0% to 3.5%). GDP breakdown (by expenditure) has yet to be published, but they think that Q4 print benefitted from robust domestic demand (mainly private consumption and investment), while net exports were, to a small extent, growth-negative. If this is true, then a combination of robust, domestic demand-led growth, strong income tax receipts, an improving labor market and a widening trade deficit in Q4, all point towards much less slack in the economy and rising core inflationary pressures over the coming quarters. That said, the sustainability of this improvement in growth will depend on both external and domestic developments (particularly mid-year wage bargaining, as this will affect household income and could trigger renewed industrial action). For now Goldman maintains its growth forecasts at 2.7% for 2012 and 3.6% for 2013, but recognizes the potential for upside risks to their forecasts if this outperformance continues into 2012. They continue to see rates on hold until 2012Q4, where a 50bps hike will take the key repo rate to 6.0% by end-year, and subsequent normalization will see the repo rate rise to 7.5% by end-2013.

Sources: Goldman Sachs Research

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 9 May 2012 | Mike’s Whiteboard Wisdom

MANUFACTURING – Current Outlook – Neutral The ISM's manufacturing composite index (PMI) declined -0.3 to 53.5 to indicate monthly expansion and a slightly decreasing rate of growth in May 2012. Despite the decline, there was strength in new orders (up +2.0 for the strongest growth since spring 2011), employment growth and inventories are down. The negatives were than backlog orders contracted and new export orders slowed.

Manufacturing activity reported a solid pickup in the New York region and, once again, continued expansion in the Chicago region. In June 2012, the Empire State index significantly slowed to 2.29. The component readings were poor for new orders, shipments, and employment as well as a slide in in the six-month outlook. The Chicago composite index also softened again to 52.7 in May 2012, but remains in expansion mode. The new orders component slowed along with production and this decline points at the risk of monthly slowing and even contraction for an increasing number of other regional surveys. The index at 52.7 is still a 2.7 points above a reading of 50 and indicating expansion.

The Philadelphia Federal Reserve's index was down in May 2012 to -16.6, dramatically missing expectations for +0.5. For the second month the index contracted and was a very severe contraction than May's minus 5.8, a reading that in itself was a shock. High mid- teen negative readings sweep the details including new orders, unfilled orders, shipments, deliveries, and the workweek.

Durable goods orders is one of the most volatile economic indicators in the U.S. The headline number was up +0.2% in April 2012 following a upwardly revised -3.7% M/M in March 2012. The major issue with this data trend is the it’s volatility. The data should be inter- preted cautiously as the overall picture for manufacturing still looks solid, with pockets that point to weakness (slowing).

Manufacturing data has been the bright spot in the recovery, but the recent data indicates an undeniable softening. Although manufacturing is still a leader, the degree of its “robustness” in clearly in question and a potential cause for concern.

Key Data Points:

► Empire State Manufacturing Survey (Federal Reserve Bank of New York): Down to 2.29 in June 2012. Provides a detailed look at New York state's manufacturing sector, how busy it is and where things are headed. Since manufacturing is a major sector of the economy, this report has a big influence on the markets. The larger the reading over zero, the greater the rate of month-to-month growth.

► Chicago PMI (Kingsbury International, LTD and Institute for Supply Management - Chicago): Down to 52.7 in May 2012. Gives a detailed look at the Chicago region's manufacturing and non-manufacturing sectors. Many market players don't realize that non-manufacturing activity is covered in this index and tend to focus on the manufacturing side only. On its own, it can be viewed as a regional indicator of general business activity. Readings above 50 indicate positive growth while numbers below 50 indicate contraction. The farther the reading is from 50, the more rapid the pace of growth or decline.

► Philadelphia Fed Survey (Federal Reserve Bank of Philadelphia): Down to -6.6 in June 2012. General conditions index from this business outlook survey is a diffusion index of manufacturing conditions within the Philadelphia Federal Reserve district. It is a good leading indicator for the index of industrial production.

► Institute for Supply Management Manufacturing Index (PMI): Down -0.3 to 53.5 in May 2012. A reading above 50 indicates the sectors are generally expanding; below 50 indicates the sectors are generally contracting.

► Industrial Production: Production & Capacity Utilization Rate (Federal Reserve Board of Governors): Industrial Pro- duction declined to -0.1% and Capacity Utilization edged down slightly to 79.0-% in May 2012. The index of industrial production shows how much factories, mines and utilities are producing. The manufacturing sector accounts for less than 20% of the economy, but most of its cyclical variation. Consequently, this report has a big influence on market behavior.

► Durable Goods Orders (Bureau of Census U.S. Department of Commerce): New Orders up to +0.2% (M/M). Excluding transportation (aircraft etc.) they were down -0.6% (M/M) in April 2012. Durable goods orders reflect the new orders placed with domestic manufacturers for immediate and future delivery of factory hard goods.

► Factory Orders (Bureau of Census U.S. Department of Commerce): Down -0.6% (M/M) in April 2012. The orders data show how busy factories will be in coming months as manufacturers work to fill those orders. This report provides insight to the demand for not only hard goods such as refrigerators and cars, but nondurables such as cigarettes and apparel.

► Business Inventories (Bureau of Census U.S. Department of Commerce): Up +0.4% (M/M) in April 2012. The level of inventories in relation to sales is an important indicator of the near-term direction of production activity. Rising inventories can be an indication of business optimism that sales will be growing in the coming months. On the other hand, if unintended inventory accumulation occurs (that is, sales do not meet expectations), then production will probably have to slow while those inventories are worked down. By looking at the ratio of inventories to sales, investors can see whether production demands will expand or contract in the near future.

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 10 May 2012 | Mike’s Whiteboard Wisdom

COMMODITIES – Current Outlook – Neutral Commodity markets, unlike other financial markets, enjoyed “spring fling” and then were completely decimated as investors completely “broke-up” with them. Commodities were mostly stuck in trading ranges since early March 2012 while volatility declined to historical lows. This was interesting given the economic growth concerns in China, European crises and tensions around Iran. However, despite their initial resilience, the individual markets remained vulnerable to increased volatility. The uncertainty in Europe along with the inter- pretation of Chinese economic data added even more pricing pressure. Many commodities finally buckled under the pressure and promptly plummeted in May. One can make a compelling case that global macroeconomic uncertainty and financial deleveraging pulled price levels below those justified by fundamentals. Given the fact that supply risks loom, commodities could easily bounce back again.

Key Commodities:

► Oil: Oil prices hovered in the 80’s and 90’s during the middle of last year and then broke out in November. The spot price of crude eased modestly this the second week of December, but rose steadily during the first 4 months of 2012. The spot price for West Texas Intermediate nudged up to close April at $104.93, and then got pounded down to $86.53. Despite the notable slowdown in global economic growth, we continue to expect that oil demand will grow well in excess of production capacity growth.

► Natural Gas: According to Natural Gas Weekly, with temperatures warming for this reporting period, natural gas prices climbed when compared to April. The Henry Hub price closed at $2.39 per MMBtu May 30th, down 21 cents per MMBtu from last the previous week’s $2.60 close .

► Precious Metals: Gold hit $1,923.70/troy oz. on September 6, 2011, but corrected viciously and finally closed 2011 at $1,565.00. As we predicted, and despite the volatility, prices closed up again at $1,663.20 on April 27, 2012, but corrected again to close at $1,560.43 on 5/31/2012.

U.S. INDICIES – Current Outlook – Negative The fear trade came back with a vengeance in May, fortunately the Fed is keeping monetary policy extremely loose even though QE3 is highly unlikely. There is still significant risk from Europe (PIIGS - especially Spain and Greece) that will probably continue to cause volatility. For the year-to-date, major U.S. indexes lost considerable value (-6% to -8% of April highs), but are still up as follows: the Dow, up 1.44%; the S&P 500, up 4,19%; the Nasdaq, up 8.53%; and the Russell 2000, up 2.82%.

Key Indices:

► Dow Industrials - 12,393 (05/29/2012): The Dow is best known U.S. index of stocks. A price-weighted average of 30 actively traded blue-chip stocks, primarily industrials including stocks that trade on the New York Stock Exchange. The Dow, as it is called, is a barometer of how shares of the largest U.S. companies are performing.

► S&P 500 - 1,310 (05/29/2012): The S&P 500 Index is one of the most commonly used benchmarks for the overall U.S. stock market. It is an index of 500 stocks that are chosen on the basis of market size, liquidity, and industry grouping, among other factors. The S&P 500 Index is designed to act as a barometer for the overall U.S. stock market; it reflects the risk-return characteristics of the large-cap universe. Companies included in the index are selected by the S&P Index Com- mittee, a team of analysts and economists at Standard & Poor's. The S&P 500 is a market value weighted index: Each stock's weight in the index is proportionate to its market value.

► NASDAQ - 2,827 (05/29/2012): The Nasdaq is a computerized market or exchange that facilitates trading by providing price quotations on more than 5,000 actively traded over the-counter stocks. Created in 1971, the Nasdaq was the world's first electronic stock market. Stocks on the Nasdaq traditionally are listed by using four or five letters as their ticker sym- bols. If a company is a transfer from the New York Stock Exchange, the symbol may consist of three letters. Some companies are listed on two exchanges and are called dually listed stocks.

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 11 May 2012 | Mike’s Whiteboard Wisdom

ECONOMIC INDICATORS – Current Outlook – Neutral

GDP growth was downwardly revised from 2.2% to 1.9% in Q1 2012 with a major drop in government spending pulling down the number. Fortunately, consumer spending accelerated. Q1 2012 GDP growth eased -0.8% from 3.0% in Q4 2011 and was lower than analyst expectations of 2.5%. Personal consumption expenditures, exports, residential fixed investment, private inventory investment, and non- residential fixed investment were all positives. There was a reduction in federal government spending and a decrease in state and local government spending.

The Conference Board's index of leading economic indicators (“LEI”) recorded a small, better-than-expected positive (+0.3%), in May 2012. It was up from -0.1% in April. The two notable negatives were factory workweek and stock prices, Neither were surprising. Gains among the other components were broad, led by building permits, loose monetary policy, spread between short and long rates, momentum in the manufacturing sector (ISM new orders), and credit conditions. Despite the other indicators, the data paints a slow- growth economic picture, which is interesting given the continued Eurozone headwinds overseas.

The U.S. non-manufacturing sector slowed a bit in May 2012, but most was on the employment component, according to ISM data. There was a +0.2 point gain to 53.7, but still indicating growth at above 50. New orders and backlogs both rose. On the negative side, export orders contracted due primarily to a slowing in Europe and China, the U.S.’s largest trading partners.

The U.S. Trade Deficit/Gap contracted (improved) in April 2012, which was unexpected given the drop in imports. The trade gap narrowed to -$50.1 billion, led by the non-petroleum goods deficit which narrowed to $36.5 billion from $338.0 billion in April. The petroleum goods gap also shrank-to $28.0 billion from $28.6 billion. The services surplus decreased slightly to $14.8 billion from $14.9 billion . Exports (-0.8%), although negative, outpaced imports which fell sharply (-1.7%) after a large jump in March 2012.

Many economists and analysts are revising 2012 GDP growth estimates. Growth in 2012 will probably be tempered and recent data is continues to signal slow recovery (potentially more sustainable) throughout the rest of 2012.

Key Data Points:

► Real Gross Domestic Product (GDP): Expanded 1.9% in Q1 2012 (May 2012 estimate). Gross Domestic Product (GDP) is the broadest measure of aggregate economic activity and encompasses every sector of the economy. The four major cate- gories of GDP - personal consumption expenditures, investment, net exports and government - all reveal important information about the economy and should be monitored separately. One can thus determine the strengths and weaknesses of the economy in order to assess alternatives and make appropriate financial investment decisions. Real GDP growth is always quoted at a quarterly annual rate. It measures how much the economy has grown over a three-month period. Quar- terly growth rates are often volatile; consequently, economists also like to look at the year-over-year growth in GDP. The yearly changes tend to be more stable.

► Leading Economic Index - LEI (The Conference Board): Down to -0.1% in April 2012. The Leading Economic Index (LEI) is essentially composite averages of several individual leading indicators. It is constructed to summarize and reveal common turning point patterns in economic data in a clearer and more convincing manner than any individual component - primarily because it smoothes out some of the volatility of individual components.

► Institute for Supply Management Non-Manufacturing Index (PMI): Up to 53.7 in May 2012. Also called the Service Sec- tor Index, the non-manufacturing ISM surveys nearly 400 firms from 60 sectors across the United States. Nonmanufactur- ing industries, including agriculture, mining, construction, transportation, communications, wholesale trade, local government and retail trade – account for 90% of total U.S. employment. For this very reason, it may be more telling of the economy’s fundamental strength.

► International Trade: Deficit shrank to -$50.1 billion in April 2012. Changes in the level of imports and exports, along with the difference between the two (the trade balance) are a valuable gauge of economic trends here and abroad. While these trade figures can directly impact all financial markets, they primarily affect the value of the dollar in the foreign exchange market. Exports grow when foreign economies are strong. The weaker the foreign exchange value of the dollar, the less expensive goods and services are to foreigners, and this also helps spurt export activity. Imports grow when U.S. economic growth is robust. Imports are also spurred by a strong foreign exchange value of the dollar.

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 12 May 2012 | Mike’s Whiteboard Wisdom

MID-YEAR REALITY CHECK: COVERING YOUR BASES IN UNCERTAIN TIMES Imagine playing a complicated game, but the rules of the game are changing, and the new rules have yet to be announced. That's what income tax planning is like this year. In fact, if there was ever a year to spend some quality time with your financial professional, this is it. Here are a few items to discuss.

How will higher rates next year affect you?

Federal income tax rates are scheduled to jump in 2013, with the bottom (10%) rate disappearing, and the top rate increasing from 35% to 39.6%. Starting in 2013, high wage earners--those with wages exceeding $200,000 ($250,000 for married couples filing jointly and $125,000 for married individuals filing separately)--will also have to pay an additional 0.9% in the hospital insurance (HI) portion of their payroll tax, commonly referred to as the Medicare portion.

Could the current federal income tax rates be extended again? Of course, but it's far from a certain bet, and the odds are that any action would not take place until after the presidential election. That means any financial plan you put in place has to account for this uncertainty. And the uncertainty extends beyond just tax rates, because a number of popular tax breaks are also scheduled to expire at the end of the year, while others have already expired. So, any potential moves have to be considered in the context of several "what if" scenarios. For example, if you have the opportunity to defer compensation to next year, you have to really think about whether that makes sense, or if you would be better off paying tax on the income at this year's rates.

Potential investment moves

In addition to increased tax rates on earnings, the rates that apply to long-term capital gain and qualifying dividends are scheduled to increase in 2013. The maximum rate on long-term capital gain will jump from 15% to 20%. And while qualifying dividends currently benefit from being taxed at the rates that apply to long-term capital gain, in 2013 they'll be taxed at ordinary income tax rates. Also beginning in 2013, a new 3.8% Medicare contribution tax will be imposed on the net investment income of individuals with modified adjusted gross income that exceeds $200,000 ($250,000 for married couples filing jointly and $125,000 for married individuals filing separately). That means someone in the top tax bracket could potentially end up paying tax on some investment income at a total rate of 43.4%.

Potentially higher rates in 2013 could be a motivating factor in your investment strategy. For example, you might want to consider selling investments that have appreciated in value to recognize long-term capital gain in 2012, before the maximum rate is scheduled to increase. Alternatively, you might consider timing the sale of an investment to postpone the recognition of a capital loss until 2013, when it could be more valuable.

Roth conversions - is this the year?

There If you've been on the fence about converting traditional IRA funds or pretax 401(k) contributions to a Roth account, you ought to give the matter one last hard look before the year ends. That's because when you convert a traditional IRA to a Roth IRA, or pretax dollars in a 401(k) plan to a Roth account, the converted funds are subject to federal income tax (to the extent the funds represent investment earnings, tax-deductible IRA contributions, or pretax 401(k) contributions) in the year that you make the conversion. Important Note: A conversion may place you in a higher tax bracket than you are in now.

If tax rates go up next year, so will the effective cost of doing a Roth conversion. Additionally, qualified distributions from Roth IRAs and Roth 401(k)s are free from federal income tax. That could make a big difference in retirement if you're paying tax at a higher rate at the time. Whether a Roth conversion is right for you depends on a number of factors. If it makes sense for you, though, it might pay to think about acting now, rather than later.

Page 13 May 2012 | Mike’s Whiteboard Wisdom

CONCLUSION

Equities followed up on a disappointing April with very challenged May. In fact, it was the worst month for the Dow in two years and one that pushed the Global Dow into negative territory for the year. As problems in Europe mounted, the “risk-off” mode went into full swing and more investors sought security in sovereign debt that seemed to offer at least some refuge from the difficulties of Greece and Spain. That demand pushed the yield on 10-year U.S. Treasury bonds to 1.63% (the lowest level seen in decades) while short-term German debt was auctioned with a coupon rate of zero. Yes, that a zero...as in nill, nothing. Concern about the euro's stability pushed its value from $1.32 at the beginning of the month to under $1.25. As the dollar strengthened, oil prices dropped precipitously from $104.93/barrel at the end of April to $86.53. Not to be outdone, gold joined the party and lost -7% to end the month around $1,560.43/oz.

The strength in the manufacturing sector was tested as many indicators slowed and economic fundamentals eroded testing investor faith which remains incredibly delicate. From our vantage point, and I’ll reiterate, it is truly one gigantic exercise in behavioral finance. Risk carries a “recency effect” (i.e. investors’ most recent investment experiences are often what they expect to happen in the future). In the investment world, this often turns out to be precisely the wrong thing to do. Due to the Great Recession and incredible volatility over the past 2 years, investors are simply still terrified. The European overhang continues to be an issue, unemployment remains above 8% and the housing market (although improving slightly) is still struggling. Despite these overhangs, the U.S. consumer remains fairly resilient and active, although the recent data is indicating that the consumer is also pulling back.

There are many negative undercurrents in the U.S. economy, and the new crisis with the Spanish banking system makes the European threat even more scary. However, the Fed is watching closely and may act, once again, to help stimulate the fledgling domestic economy. Only time will provide more clarity on whether Europe can contain their ever-evolving crises and if continued improvement in U.S. fundamentals can prompt further financial market advances.

As usual, our advice is to remain flexible, nimble and prepared for both “market corrections” and volatility.

As always, we are watching the markets and economy intensely on an ongoing, daily basis.

We believe that the key to successful investing is predicated upon a thorough investment process, a carefully crafted investment plan that includes an understanding of the true nature of investment risk and continual monitoring and evaluation of that plan as the highly dynamic economic climate changes. We believe that in order to achieve investment objectives, investors must:

► Accept that bear markets are recurring and inevitable. Accordingly, they must be built into the overall long-term investment plan.

► Have a carefully constructed investment plan and stick to that investment plan when market pundits, the media, and word-of -mouth chatter is filling the general public’s head with speculative mania or tales of approaching Armageddon.

► Understand that “sticking to your plan” does not have to mean “buy and hold”. It includes active management and having an exit strategy based upon “black swan” or unanticipated market events like those experienced in 2008. It includes constant evaluation and sector reallocations to help take advantage of prevailing market conditions and future outlook. It can also mean searching for tax-loss harvesting opportunities and alternative investment vehicles that can help hedge or take advantage of deteriorating market conditions

► Understand the relationship and tradeoffs between risk and return and, most importantly, your own ability, willingness and need to accept market risk, and avoid taking on more or less than makes sense for you.

JOIN US AND GET THE ATTENTION YOU DESERVE. INDEPENDENT. OBJECTIVE. FOCUSED. PROFESSIONAL.

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 14 May 2012 | Mike’s Whiteboard Wisdom

FIRM OVERVIEW SCP SERVICES At Schmitz Capital Partners our focus is on the client. SCP strives to provide our clients with unbiased advice within a We strive to simplify and enhance the quality of our clients’ broad spectrum of financial advisory services including: lives through active portfolio management and highly cus- ► Investment Advisory Services (Portfolio Management) tomized financial advice tailored to each individual’s unique • Retirement Planning needs. We are deeply committed to providing exceptional • Retirement Income Planning service and to forging genuine relationships established • Pension & Profit Sharing Design through mutual respect, compassion, trust and understand- • Non-Qualified Deferred Compensation ing. As a premier provider of comprehensive financial ad- ► Estate Planning vice for over 22 years, our firm’s objective is to build lasting, • Trust Services Education Planning long-term relationships based on expert counsel, trust and ► ► Financial Planning quality service that exceeds expectations and helps our ► Income Tax Planning clients achieve their life goals. ► Insurance Services

PHILOSOPHY SCP FAST FACTS

Our investment philosophy is simple: to provide conflict- Custodian Pershing LLC free, unbiased, trusted investment advice in order to help our clients achieve their financial milestones. Our Broker-Dealer Royal Alliance Associates, Inc. investment philosophy is rooted in a long-term approach to growing client assets through active management, broad Approximate AUM $108MM asset allocation, diversification, and risk management while helping to build both confidence and financial independ- Years In Business 23 Years (Founded in November 1988) ence. At SCP, we look to provide reasonable long-term investment results by building globally diversified portfolios Portfolio Management Style Active/Tactical and proactively managing asset allocation decisions.

SCP’s investment philosophy is based on the following: Advisory Clients 177

► Trust Brokerage /Non-Brokerage 314 ► Consistent Participation Clients ► Global Thinking ► Broad Asset Allocation and Diversification Advisory Fee Structure Based on Assets Under Management. ► Active Management Please see SCP’s website or Form ADV ► Performance Part 2A for a more detailed breakdown. ► Risk Management and Education ► Professional Management Account Minimum None (case by case basis)

WHY SCP? INVESTMENT MANAGEMENT TEAM

We are truly different. Our investment philosophy, proac- tive portfolio management techniques and client service STEVEN J. SCHMITZ approach sets us apart. We are convinced that building Portfolio Manager globally diversified portfolios and proactively managing • Founder, President & Chief Investment Officer asset allocation decisions are prerequisites for achieving 38 years of experience long-term financial objectives. We believe our firm’s distinc- • Education: B.S., Cum Laude, Mechanical Engineering, Santa Clara University tive characteristics - our independence, experienced multi- M.B.A., with Honors, Anderson School of Management, UCLA generational team, client-centric focus, collaborative cul- Post-Graduate Studies, Accounting & Taxation, Golden Gate University ture, highly flexible and customized advice, stability, com- • Securities Registrations: Series 7, 24, 63 mitment to full transparency and ethical values - provide us • Insurance Licenses: California Life, Health, Disability and Annuities Agent with a competitive edge in guiding investors through bull and bear markets. MICHAEL J. SCHMITZ

The “SCP difference” is characterized by the following: Portfolio Manager • Vice President - Investments & Chief Operating Officer ► Independence 15 years of experience ► Experience • Education: ► Client Service B.S., Finance, Leavey School of Business, Santa Clara University ► Senior-Level Attention Post-Graduate Studies, Professional Certificate in Financial Planning, New York University ► Flexibility • Securities Registrations: Series 7, 63, 65 Customization ► • Insurance Licenses: California Life, Health, Disability and Annuities Agent ► Transparency & Stability • Professional Designations: ► Guiding Firm Principles • CMFC® (Chartered Mutual Fund CounselorSM) ► Ethical Values • RFC® (Registered Financial Consultant)

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 15 May 2012 | Mike’s Whiteboard Wisdom

DISCLOSURES

This market commentary are the property of Schmitz Capital Partners and are intended for the exclusive use of clients and business associates of Schmitz Capital Partners (“SCP”). Unauthorized reproduction or distribution of this material in whole or in part is strictly prohibited. If you have any questions, please contact Michael Schmitz at (415) 381-9076, via email at [email protected] or via regular mail at Market Commentary/emails | 655 Redwood Highway, Suite 109 | Mill Valley, CA 94941 for further information.

This information has been prepared by Michael J. Schmitz and the material reflects the views of Schmitz Capital Partners and is for informational pur- poses. It does not take into account the particular investment objectives, financial situation, or needs of individual clients. Statements made by various authors, government agencies, professionals, advertisers, sponsors and other sources do not necessarily reflect the opinions of SCP or Royal Alliance Associates, Inc. (“RAA”), and should not be construed as an endorsement by SCP or RAA, either expressed or implied. Opinions expressed herein are current opinions only as of the date indicated, and are subject to change without notice. This material is based upon information obtained from various sources that Schmitz Capital Partners believes to be accurate and reliable, but SCP makes no representation or warranty with respect to the accuracy or completeness of such information. SCP is not responsible for typographic errors or other inaccuracies in the content. Therefore, all information and materials are provided "AS IS" without any warranty of any kind.

Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Certain of the statements contained herein are statement of future expectations and other forward-looking statements that are based on current views, forecasts and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels,(4) increasing levels of loan defaults, (5) changes in laws and regulations, (6) changes in the policies of governments and/or regulatory authorities and (7) inflation. Past results are not indicative of future results.

Note: Michael Schmitz is the Vice President of Investments, Portfolio Manager and Chief Operating Officer for Schmitz Capital Partners (“SCP”), which is an investment advisory firm registered with multiple states (see below). Michael Schmitz is a registered representative of Royal Alliance Associates, Inc., (“RAA”) a FINRA registered broker-dealer. Opinions expressed in these reports may change without prior notice. Michael Schmitz and/or the staffs at Schmitz Capital Partners may or may not have investments in any securities cited in this commentary.

Securities offered through Royal Alliance Associates, Inc., member FINRA/SIPC. Investment advisory and insurance services offered through Schmitz Capital Partners, a Registered Investment Advisor not affiliated with Royal Alliance Associates, Inc.

Royal Alliance Associates, Inc. does not provide tax advice.

This communication is strictly intended for individuals residing in the states of AR, AZ, CA, CO, GA, HI, IA, ID, MA, MT, NC, NJ, NV, NY, OH, OR and WA. No offers may be made or accepted from any resident outside the specific state(s) referenced.

Investing involves risk including the potential loss of principal. No investment strategy such as diversification or asset allocation can guarantee against a profit or protect against loss in periods of declining values. Global investing involves special risks including greater economic and political instability, as well as currency fluctuation risks, which may be even greater in emerging markets.

Please note that rebalancing investments may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events will be created that may increase your tax liability. Rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment.

Technical Analysis is based on the study of historical price movements and past trend patterns. There is no assurance that these movements or trends can or will be duplicated in the near future. It logically follows that historical precedent does not guarantee future results. Conclu- sions expressed in the TA section are personal opinions; and may not be construed as recommendations to buy or sell anything

Indexes cannot be invested in directly, are unmanaged and do not incur management fees, costs and expenses.

The price of commodities is subject to substantial price fluctuations of short periods of time and may be affected by unpredictable international monetary and political policies. The market for commodities is widely unregulated and concentrated investing may lead to higher price volatility

In general, the bond market is volatile as prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Alternative investments involve specific risks that may be greater than those associated with traditional investments and may be offered only to clients who meet specific suitability requirements. You should consider the special risks with alternative investments including limited liquidity, tax considerations, incentive fee structures, potentially speculative investment strategies, and different regulatory and reporting requirements.

While a stop or stop-limit order is designed to have control over when an order is filled, this strategy cannot guarantee a profit or protect against loss in any market condition.

IMPORTANT CONSUMER INFORMATION

A broker/dealer, investment adviser, BD agent, or IA rep may only transact business in a state if first registered, or is excluded or exempt from state broker/dealer, investment adviser, BD agent, or IA registration requirements as appropriate. Follow-up, individualized responses to persons in a state by such a firm or individual that involve either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made without first complying with appropriate registration requirements, or an applicable exemption or exclusion. For information concerning the licensing status or disciplinary history of a broker/dealer, investment, adviser, BD agent, or IA rep, a consumer should contact his or her state securities law administrator. DISCOVER | DEFINE | DEVELOP | DESIGN | CONSTRUCT | MONITOR | EVALUATE

655 Redwood Highway, Suite 109 Mill Valley, CA 94941 (415) 381-9076 D (415) 381-2917 F schmitzcapital.com

Page 16