Peak

August 20, 2010

Theories
Abigail F. Doolittle Research
abigail@peaktheories.com
518-391-9313 LLC
www.peaktheories.com

Current Commentary on the Primary Financial Market Trend

The Weekly Peak

The Uncertainty of the Micro versus the Macro
I often write about how uncertainty is the fuel for market volatility, and thus the very volatile picture of the S&P 500 over the last year reflects,
in my opinion, tremendous uncertainty about the true direction of the economy.

At the heart of this investor uncertainty, or even confusion, is the battle between the micro-economic data and the macro-economic data.

By micro-data, I mean corporate profits. Considering that 82% of U.S. companies beat expectations in the most recent earnings season, it’s
understandable that investors could believe the economy is on the mend. This view is reinforced by the fact that many of those same
companies raised earnings and, in some cases, revenue guidance for the remainder of 2010.

The macro-data, on the other hand, is not so positive. In fact, it’s downright dismal when we look at the bleak state of the employment
situation, the housing market, and bank lending not to mention shrinking GDP.

While investors collectively seem not to know what to make of this spar, I offer one analogy and one explanation as to why the macro-data will
dominate and destroy the micro-data.

This American Block

Back in the day, I covered a rather amusing portfolio manager who would tell me, “I’ll never buy a good house, even a great house, on a bad
block. I want the beat-up house on the good block.”

As an equity salesperson, we weren’t talking real estate. This was his way of talking about stocks and sectors.

If we extend this analogy to the American economy, the block is big and it’s made of lots of different houses per say. Specifically and perhaps
this list misses the mark exactly, but these are the “houses” on the American block in the global neighborhood.

Gross Domestic Product Labor Productivity Bank Credit at All Commercial Banks
Real GDP Industrial Production Consumer Credit
Implicit Price Deflator for GDP Capacity Utilization Interest Rates and Bond Yields
Business Output New Construction Stock Prices and Yields
National Income Existing Home Sales Ind. Prod. And CP of Industrial Countries
Consumption Expenditure Business Sales and Inventories U.S. Int’l Trade in Goods and Services
Corporate Profits Manuf. Shipments, Inventories, and Orders U.S. International Transactions
Real Gross Private Domestic Investment Producer Prices Federal Receipts
The Unemployment Rate Consumer Prices Federal Outlays
Level of Civilian Employment Money Supply Federal Debt

Now I’m not going to grade or rate each of the above categories, I’ll leave that to the economists and various organizations, but I think it is
more than fair to say that the majority of these areas continue to struggle after the ravages of the Great Recession. So much so that even the
National Bureau of Economic Research's Business Cycle Dating Committee is unwilling to call the official end of the recession that they say
started back in December 2007.

In particular, the employment situation, the housing market, and the figures related to money supply and bank credit remain very weak.

There’s one area, one “house”, however, that’s thriving: corporate profits. This one house is what has so many investors hopeful that a turn in
the economy is around the corner. However, when this one house, a very cute house that appears to look a little better with each season, is
seen among the increasing disrepair and even decay of all of the other houses, it looks less and less like a house you’d want to live in let alone
buy.

Peak Theories Research LLC is an on-line research firm dedicated to providing investors with a macro long-term view on the
financial markets and the economy. Please see important disclosure statements at the end of this document.
 Peak
August 20, 2010
Theories
The Weekly Peak Research
LLC
www.peaktheories.com

This is especially true considering that it, and all of the houses, the entire American block sit in the shadow of the biggest house of them all or
Federal Debt.

A Closer Look at the Cute House

We’ve established that the block is bad, perhaps, but I think it’s worth taking a cursory look at what some investors are getting excited about
and what’s causing them to believe the economy’s on the mend: corporate profits.

As I mentioned earlier, 82% of companies beat profit expectations in this past earnings season. In fact, this was actually the fourth consecutive
quarter in which companies handily beat expectations, making it the best four-quarter period of upside earnings announcements since 1990.

So far, it sounds pretty good. However, when we dig into the composition of corporate profits and the expectations against which actual
earnings are measured, the story starts to shift.

First, corporate profitability these days, and for at least the preceding 274 days, is all about cost-cutting and increased worker productivity
rather than consumer spending. Revenue beats occurred for less than 50% of the companies comprising the S&P 500.

Cost-cutting is finite as is increased worker productivity. Some companies have sought top-line growth by expanding abroad rather
aggressively, but this too can move the numbers only so far. At some point, there has to be real and sustained end-user demand in the form of
consumer spending on level pricing. Otherwise revenue growth will shrink as will profitability at some point.

Second, we must remember the powerful thinking of Art Laffer, who penned an excellent opinion piece in The Wall Street Journal with one of
the best titles of all time or Tax Cuts and the 2011 Economic Collapse. Although it is not the pinnacle point of the piece, Mr. Laffer makes the
case that corporations may be pulling 2011 revenue and production into 2010 so as to avoid the likely increased taxation of 2011. And while
this doesn’t seem to be showing up on the top-line so much, it doesn’t mean it’s not happening. Perhaps without that pull-through revenue
numbers would have been coming in light and earnings figures in-line.

It’s at least worth keeping in mind when thinking about corporate profits for 2010.

Third, sell-side analysts are low-balling it. Analysts are publishing revenue and earnings expectations that are so low, so meet-able, so beat-
able that 82% of companies beat those expectations for the second quarter of this year.

As some small stick of proof outside of the common knowledge as to how that investment banking game works, after the first quarter of this
year when companies topped the previous year’s earnings by nearly 20%, analysts responded by raising second quarter forecasts by less than
2%. This, of course, has lagged the actual earnings growth put up of more than 10%.

If I’m being kind, analysts are looking at the “block” and are refusing to believe that U.S growth can sustain strong corporate profitability
forever. They may even be scanning the global neighborhood flooded by debt and becoming more resolute in their view that global growth is
likely to slow and this will affect corporate profitability at some point. The other explanation, of course, is that aforementioned game.

Whatever the reason, it’s clear that it’s not particularly hard for companies to beat earnings expectations when said expectations are buried in
the ground. When we consider that the quality of those beats may be suspect as well, it’s worth considering whether the cute house is so cute
after all.

Chambers Talks Macro and Micro

An interesting and recent earnings report may provide us with a look at what can happen to a good house on the bad block: Cisco Systems.

On the company’s recent fiscal year-end’s quarterly call, CEO John Chambers gave a less than inspiring macro-picture outlook even though he
didn’t want to “make a call on the economy.” However, he did provide investors with a bit of macro-color in talking about the fact that his
company is seeing “mixed signals” and “unusual uncertainty” and a large degree of conservatism and caution from his customer base.

The result? Well, you all know that the company managed to beat earnings expectations by a penny but missed revenue expectations. In

Peak Theories Research LLC is an on-line research firm dedicated to providing investors with a macro long-term view on the
financial markets and the economy. Please see important disclosure statements at the end of this document.
 Peak
August 20, 2010
Theories
The Weekly Peak Research
LLC
www.peaktheories.com

addition, and more importantly in my view, the company lowered its FY Q1:11 sales view to a range of $10.64B - $10.83B versus expectations
of $10.95B.

Considering that Chambers gave his most famous “macro talk” in FY Q1:07 with a reporting date of November 7, we may want to pay attention
to what Chambers said last week. I say this because that last macro talk marked the literal top for the NASDAQ to the day.

While the high has already come for the NASDAQ along with the other major indices, in my opinion, it’s worth noting that there was a roughly
55% slide down from November 6, 2007 and the index’s current bear market low on March 9, 2009.

Perhaps John Chambers and his “macro talks” have an odd way of making sense of the micro and the macro by showing that the macro tends
to consume the micro.

Sam’s Stash, Gold, and the S&P

Very interesting is what all of this uncertainty looks like in one cohesive, real-world picture of Treasurys, the U.S. dollar, gold, and the S&P 500.

Broadly speaking, uncertainty appears to coincide with, if not cause, correlation. We’re living in a time when risk correlates to risk in extreme
and unexpected ways while safety correlates to safety in a response to volatility that is fed by uncertainty.

Starting off with safety, we’ve seen an increasing flight to it this year.

Treasurys have strengthened tremendously with the 2-year yield at a record low and the 10-year and 30-year yields at levels last seen in March
2009 and the depths of investor despair.

The U.S dollar has also benefited from this flight to safety considering it’s up nearly 6% on the year.

Gold is also benefiting from this flight to safety having gained about 11% on the year and despite the fact that it is effectively more expensive in
U.S. dollars. In fact, gold is not so far from its all-time high made less than two months ago.

Clearly there’s enough uncertainty going around to keep each of these asset classes strong with each seeming to get stronger every day.

However, due to the hopes around corporate profits and what those positive reports might mean for the economy, investors have not been
willing to shed risk. In fact, this has been one the great flirtations of the past year as shown below with buyers streaking in and out of the S&P
500.

In the end, however, I believe that safety will prevail as the “badness” of the block outweighs the “goodness” of the few cute houses on it. This
flight to safety may be heightened when the stench of the debt swamp that’s flooding the global neighborhood becomes a bit stronger as it
will.

Peak Theories Research LLC is an on-line research firm dedicated to providing investors with a macro long-term view on the
financial markets and the economy. Please see important disclosure statements at the end of this document.
 Peak
August 20, 2010
Theories
The Weekly Peak Research
LLC
www.peaktheories.com

And so what do I think this will look like?

I think that in the near- to mid-term Treasurys will remain very strong with the 10-year brushing below its record lows made in the fall of 2008
when it falls to 2%. I think the dollar will continue to move higher and perhaps significantly higher as the European implosion resumes. I think
gold is more likely than not to move higher for some period of time although I’ve no clue how high and I’m thinking through for how long.

And the S&P 500, well the S&P 500 is what led me into all of this in first place in thinking it is going lower, significantly lower. I continue to
believe that there is a very real possibility that the index will decline to 100 while I have no doubt that it will go to at least 425.

Interestingly, however, as the latter event happens, as the S&P 500 starts to crash, two of the safe-haven assets will start to become risk-
bearing assets.

I’m talking about Treasurys and the U.S. dollar. When it becomes clear that the Federal Debt of the United States is utterly unsustainable and
investors require a much higher return to hold U.S. debt, it is likely then that the United States will follow decades of poor monetary and fiscal
policy with worse policy and print dollars to support its debt.

When that event happens, and I strongly believe it will in whatever form it may be, Treasurys and the dollar will both be risky assets to hold
while the S&P will start to become a bit safer nestled in a bottom of sorts.

For all of these reasons, I urge you to think carefully about how you invest in Treasurys, what physical and tangible assets you may want to pour
your U.S. dollars into before it is devalued, and, of course, I urge you to sell equities today.

And gold? Well gold is taking on a life of its own for me and I need to think about it a bit more before I write exactly and precisely what I might
urge you to do but rest assured it will be a combination of everything I’ve put out on the topic.

As always, thank you for taking the time to read this week’s piece.

Peak Theories Research LLC is an on-line research firm dedicated to providing investors with a macro long-term view on the
financial markets and the economy. Please see important disclosure statements at the end of this document.
 Peak
August 20, 2010
Theories
The Weekly Peak Research
LLC
www.peaktheories.com

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Peak Theories Research LLC is an on-line research firm dedicated to providing investors with a macro long-term view on the
financial markets and the economy. Please see important disclosure statements at the end of this document.