HOUSE_OVERSIGHT_025239.jpg

drive income, and ongoing regulatory uncertainty. Most US banks are at or close to Basel 3 funding needs, have considerably fewer capital adequacy questions than their European counterparts, and do not rely on wholesale funding to finance loan portfolios. S&P 500 ex-bubble price to earnings multiple Price to next twelve months operating EPS US bank price to book ratio 45x 24x 40x Datastream 22x 3 5x 20x 30x si 25x 16x 20x 4 Morgan Stanley 14x 15x we 1.0x 10x 05x 8x —— 0.0% 985 1988 199 94 1997 2 3 ¢ 1988 1991 1984 1997 2000 2003 2006 2009 2012 “""1969 1973 1977 1981 1986 1990 1994 1998 2002 2006 2010 Source: IBES, Standard & Poor's Now that P/E multiples have risen off the bottom, what’s the outlook for P/E multiples and earnings from here? The return on the S&P this year has been a function of P/E multiples rising (from 11.3x to 12.9x), a big part of which has been Apple (3% of the S&P index, 15% of S&P’s YTD returns). As shown below, earnings revisions have been negative for 2012, but analysts are still optimistic about 2013. According to Morgan Stanley, analysts are forecasting the highest percentage of companies posting 2013 margin expansion since 1970, and by a very wide margin. In our view, it will be difficult for multiples to rise further unless earnings outperform expectations, particularly if Europe’s structural problems take center stage again. Revisions to consensus EPS by quarter Index, 12/30/2011= 100 101 4QE+1% 100 SQE -1% 99 FYd2-1% 98 2QE -2% of 1QE =3% O68 12/30/7011 OVS2012 O2/2o/2012 OS28e012 Source: FactSet The place that worries me the most: Spain. It ranks at or close to the bottom in a lot of categories (see table), and its growth outlook is poor. Historically, this kind of thing has not ended well. Spain has defaulted 13 times since 1500 AD; it’s probably going to take a lot of bilateral aid and ECB financing to prevent another one. HOUSE_OVERSIGHT_025239