Focal Points

Page 2

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June 8, 2010

Sta te of th e Ma rket: Credit vs. Commodities & Jobs

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The frail state of the markets is now becoming more obvious and as such the audience for our call to cash is growing. The difficulty in getting our message out is that in its raw form (how we normally write), the argument is quite technical:

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Client

: Why go to cash?

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Quant/Technical

: Look at the euro-dollar basis swap pricing!

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Client

: Say what??

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Now, however, the market is showing signs that everyone can easily recognize as indicative of economic weakness:

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job growth has stagnated , and

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These new signs are not new information on why things are bad. Rather, they are symptoms, or outward displays of how weak the credit market has become.

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Weakening credit conditions are the cause.

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Economic fallout is the effect.

Our Job : How Do We O perate? What Do We Know ? What Don’t We Know ?

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You will notice that the vast majority of our work includes charts. Charts are factual observations that convey the current and historical state of the market.

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In these charts, we detail the evidence of how the markets behave, or, more importantly, how they are priced. This is what we care about; how the market prices, and how this may change day by day, hour by hour, and tick by tick.

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We observe markets as a scientist observes an experiment. In this case, it is a social experiment, entitled “capital markets.”

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What we find intriguing is seeing relationships change. When markets start to price things differently, our hunt is on for why pricing is changing, what it means, and where it might take markets.

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What we find now in the market pricing is disturbing, which is why you are reading this.

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The nature of our work stems from observation of the markets, as opposed to the collection of economic data.

Western European Sovereign Debt Crisis = Asian Growth Problem

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We observed that the sovereign default risk of Europe was very well connected to the sovereign default risk of Asia.

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By observation, we know there is a link and now we have part of the economic rationale for what we are seeing.

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We have what we need for our call for extreme caution:

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The funding of Asian growth is closely tied to the health of the European financial system.

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.

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went off

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The close ties between European and Asian credit are showing up in the tick charts only in times of stress, which is why we started picking up the relationship quite recently.

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