stephansen june 0611

S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

GIC Presentation Kathleen StephansenManaging DirectorHead of Economic Strategy AIG Asset Management

Helsinki- June 6, 2011

S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

Risk appetite correction

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Main takeaways: - The commodity price correction, increasingly difficult sovereign bail-out negotiations, the slowdown in global output growth and end of QE2 have all triggered risk aversion and market choppiness. - We view the economic slowdown as temporary within an otherwise moderate self-sustained cycle.

Global growth remains on a firm growth trajectory of close to 4%, down from 5% in 2010. Recent Purchasing Managers Indices (PMI) indicate a more pronounced slowdown in advanced than in emerging economies. We note the PMI declines in the US and the UK, and the moderation in the Euro area. If the Japanese earthquake played any role in the manufacturing slowdown, comfort should be drawn from the sharp rise in Japans May PMI. In emerging markets, Russia led the decline, with China and India posting only a moderate slowdown in their May PMIs. Of note, China will likely see a slowdown in industrial output and in consumer spending growth, while the hiatus in the construction of high speed trains and nuclear plants may slow investment spending. That said, monetary normalization should continue and the anticipated slowdown in growth should ease the pressure on commodity prices.

The US economic expansion remains moderate. The key drivers of the cycle are industrial production, investment, and exports. The virtuous cycle of corporate profits-job creation is in place but evolving slowly. A modest Q2 GDP rebound should be expected, thanks to these dynamics and to less of a drag from energy costs. We note headwinds: Households will continue rebuilding their net worth positions in light of still falling house prices; Poor asset quality of smaller banks will tend to curtail their lending activity. These are reminders that the US economy is not yet operating on all cylinders and therefore is lagging other cycles in terms of strength. Hence, the Feds ongoing policy assist.

Inflation is normalizing.

The Fed keeps monetary accommodation in place. However, the Fed will focus more on inflation than on the unemployment rate in determining when to normalize policy.

Risks: a) Sovereign restructuring risks (Greece); and b) US debt ceiling and fiscal policy risks; c) Regulatory risks.

S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

Risk aversion was triggered initially by the commodity price sell-off and renewed sovereign risk concerns

3Sources : Bloomberg

Exhibit 2: CRB Index

Exhibit 3: Crude Oil (WTI)

Exhibit 1: Silver

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Exhibit 4: GIIPS 10YR Cash Spreads vs. Bund

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S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

followed by signs of a synchronized global slowdown, which affected advanced more than emerging economies

4Sources : Markit; Credit Suisse; Capital Economics

Exhibit 6: The downward adjustment driven by advanced economies rather than emerging economies

Exhibit 5: Global Manufacturing PMI Index declined to 52.9 in May from 55 in April

Exhibit 7: Global new orders and exports declined in recent months, posing a downside risk to the outlook

Exhibit 8: China: Electricity output fell slightly in March but does not look weak

S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

If the Japanese earthquake played any role in the global manufacturing slowdown, we are then encouraged by the sharp rise in Japans May PMI. Input prices are easing.

5Sources : Markit;

Exhibit 10: The slowdown in the BRIC was led by RussiaExhibit 9: The rebound in the Japanese PMI is encouraging

Exhibit 11: Global input prices are easing, though remain elevated

S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

How worrisome is the current economic soft patch?

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The risk appetite sell-off underscores market fears of last years double-dip scare.

Growth momentum has softened but conditions of a double-dip are not present.- The US economic expansion is driven by manufacturing activity, investment and exports- The labor market is recovery, though very slowly- The corporate sector is solid- Economic growth will likely firm moderately in Q2- Inflation is normalizing

Headwinds remain, and that is why growth is not on a 4% growth trajectory, but rather closer to 3%. - Household wealth needs to be rebuilt- Housing sector recovery is lagging- Small banks are recapitalizing

The cycle is not a typical one, because: - Its strength remains moderate relative to recent ones (hence the on-going Fed policy assist)- It displays more volatility (i.e., more frequent slowdown/acceleration phases)

S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

Production and Investment are the drivers of the cycle: The Manufacturing ISM adjusted back closer to its long-run average following four consecutive reads above 60%, which is a rare cyclical event

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Exhibit 13: Industrial Production and Manufacturing Index (SA, 2002=100) % Change - Year to Year Exhibit 12: ISM manufacturing composite indices (SA, 50+=Increasing)

Exhibit 14: Equipment and Software and nonfarm private payrolls (rhs) Y/Y % change

Sources: Federal Reserve; ISM; Bureau of Economic Analysis; Bureau of Labor Statistics

Exhibit 15: Exports and Imports of Goods and Services (SAAR, Bil.$) y/y % change

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IP IP-Manuf

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ISM Boom/Bust Level 20-Year Avge 60-level

51.6

S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

The May employment report points to a difficult labor market recovery but nevertheless a moderate rebound in growth during Q2

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Exhibit 17: Private Non-Farm Payroll Jobs (Difference Period-to-Period)Exhibit 16: Maximization of the profit share of GDP

Exhibit 18: Payroll Income (YoY % change)

Sources: Bureau of labor Statistics; BEA

Exhibit 19: Labor Input to GDP: Index of Aggregate Weekly Hours in Total Private Industries (YoY % change)

S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

The consumer is on the mend but persistent high gasoline prices represent a downside risk

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Exhibit 22: Retail Sales: Total (BLUE) and EX Motor Vehicles (RED) (SA, Mil.$) % Change - Year to Year

Exhibit 21: Consumer Confidence Index

Sources: Census; Conference Board

Exhibit 20: Monthly: Wages and Salary (Blue) and Disposable Income (Red) YoY % change

S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

The consumer is on the mend (2): Credit demand is picking up

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Exhibit 25: Looser Standards: Credit card and other consumer loans

Exhibit 24: Consumer Credit Outstanding (EOP, SA, Bil.$) % Change - Year to Year Total (blue), Revolving (red), non revolving (green)

Sources: Bureau of Economic Analysis; Macroeconomic Advisors; Federal Reserve

Exhibit 23: Real PCE Growth and Saving Rate

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S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

Inflation is normalizing as short-term trends pick up

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Exhibit 26: CPI-U: All Items (blue) and Core (red) (1984=100 NSA) % Change - Year to Year

Exhibit 28: Owners' Equivalent Rent Prices (red) and Rental Vacancy Rates (green, Rhs,) % Change - Year to Year Exhibit 29: PPI core finished goods and core CPI (Y/Y % change)

Sources: Bureau of Labor Statistics; NAAR

Exhibit 27: Core CPI 3-month annualized % change (all items less food and energy, SA)

S T R I C T L Y P R I V A T E A N D C O N F I D E N T I A L

Long-term expectations remain well anchored, for now

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Exhibit 30: Households Inflation Expectations

Sources: Federal Reserve Bank of St. Louis; Federal Reserve Bank of Cleveland; Credit Suisse

Exhibit 31: Sticky Prices (red) and Flexible Prices CPI (blue) % Change - Year /Year

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