CIO Market Update Audiocast Series​

Joe Quinlan:              Good morning, everyone. This is the market update for May 25^th. A lot to cover today. Obviously, a lot of issues down in DC. We're finishing up earnings season. There's a lot of talk about US recession. So, I do have, for the Q&A session for our call today, Chris Gunster, who's going to do a deeper dive on fixed income, [Ehwario Efeyini] who’s going to talk about the US markets outside the United States, non-US markets - emerging markets, developed markets. I'm going to start with just kind of a data check here. I always like to start like where are we? We're almost five months into the year. The S&P as of close yesterday up 7.9% total return, the Dow basically flat, and then we got the high-flying Nasdaq up around 19.7%; even higher today based on some specific company news. As everyone knows, it's the narrow breadth driving the Nasdaq and the S&P and one of the key questions for the second half of this year will be, “How much breadth will be added to this market rally that we've seen thus far?” Overseas the emerging markets, MSCI EM up around 3.1%, Shanghai 1.5%. When you get into Europe, it's interesting that DAX and the CAC, Germany and France respectively, up around 14.3% - 14.7%. [Unintelligible] up 6.5% and Nikkei Japan we can talk about that up almost 12%. Oil prices are down 7.4% year to date, copper down 6.7% and the natural gas is down almost 46% given just the excess supply that we've seen come in really related to Europe so it's an interesting backdrop for the global equity markets as of the year to date. Remember, we came into the year all of central banks were tightening. The monetary lag was going to spill in and bleed into weaker growth in the United States and overseas and particularly into earnings, but US corporations have done a fabulous job managing their way through the higher prices and the cost of labor boost productivity and the earnings season that we just closed out came in much better than expected overall. So that's kind of where we're at. The key issue when I look out say next 6, 12, 18 months is, can these gains hold? There's a fierce debate if it’s a bear market rally or is this the beginning of a new bull market? What I want to do is just kind of take it three dimensionally and look at the markets and looking forward in three different lenses - short term, medium term, and long term and what are the key focus points. Obviously, short term, say the next couple of days/next couple weeks - hopefully that's it – the debt ceiling debate. A lot of volatility, a lot of questions I know you're getting from clients. A lot of negative headlines in and around it. We were just talking pre-conference call. I think the media makes our job/your job much harder given the fact when you hear about catastrophic and the defaults and so there's a lot of misinformation in and around that that’s going to just keep the markets on edge. It's a very fluid situation. Is the X date June 1^st? Is it June 8^th? We're still working our way through that, but we know we're going to get a debt ceiling. It's going to be raised. The key question is what type of fiscal cuts, type of spending are going to come with this package? What the democrats and republicans agree on? What's it going to look like fiscally speaking for 2023 and for 2024? That's going to be a huge issue but we're not there yet. So we may or may not go into the weekend without a deal. That's going to put the pressure when we come back on Tuesday and we get closer to June 8^th date. There’s going to be more downside pressure on the markets, but remember, we've been here before. We know how this movie ends and the key question is - what are the cuts that are going to be agreed upon between both parties between now and then? Another key issue to watch when it comes to debt ceiling - I'm watching very carefully because I talked to the people in Tokyo, Brussels, London, sovereign wealth fund. Remember, foreigners own around $23 trillion dollars of US security, so they have a lot of skin in this game as well and they're asking a lot of questions. What's that mean for the dollar? The dollar's been hanging in there. Nothing dramatic moves which tells you that the foreigners are also expecting for this drama to be over sooner rather than later. So that's the debt ceiling debate. Very fluid. Probably will go through the weekend. We're going to get it done but how much drama and collateral damage comes with a post an agreement? That's the short term. The medium term is more interesting to me and I think it should be more interesting to our clients and our discussion because when I talk medium term, I'm talking about in the next say, six – nine months and there's two big focuses here. Number one is the Fed. June - July Chris Gunster going to talk more about this as well - but there's a narrative building in the markets amongst all the Fed speak that maybe the Fed goes another 25 basis points higher in June or if they pause in June, they hike in July. So there is that ongoing debate amongst the Fed in between the markets and investors about is the Fed really done? Have we reached peak terminal rates? To be decided. Remember, headline inflation 4.9%, well above that 2% target and if the Fed is adamant about getting to that 2% target sooner rather than later or extended as Ethan talks about, then that could have some ramifications for the cost of capital. The labor market remains very tight. I travel a lot through the country. Every business I talk to is still out there looking for labor and albeit not paying as much up as it was before in terms of cost of wages and salaries, but nevertheless with 3.4% unemployment rate, inflation double what the Fed target is, the Fed still very much in play when it comes to what happens next, so that's something the markets have to deal with and kind of work through in the next couple of weeks/next couple of quarters and Chris will talk to that. The other issue is the US recession. As you know, our economists are looking for the recession to begin in Q3 and Q4 into next year. Is it going to be shallow? That's the call thus far but remember when it comes to the recession call, something I want you to kind of remember and something I've been reminding clients quite a bit - recessions are not uncommon in the United States. In the post war era, we've had a dozen or so recessions and recessions to me, typically they're ways to reset, rejuvenate, and really help drive future growth. Think of recession this way – it’s not like if I go to my doctor and he says, “Joe, I'm sorry you got recession. Go home, get your affairs in order, tell your wife and kids it’s over." No, that's not a recession. Recessions are ways that we reset and get this resilient economy back on its footing. The weak go under, the strong get stronger, and we push ahead. So, I'm leaning into this recession scary talk amongst our clients because they have to realize that on the other side of this recession, say a year from now or the second half of 2024, we're going have a much more competitive economy. We always typically come out of a recession stronger in the United States and that's very unlike Japan or Europe, other parts of the world in the sense that when they have a recession, they keep the companies open, they get state subsidies, they’re not allowed the fire, and on down the line. So really what we do best in the United States is create and destroy and destroy and create. So, think of it that way. Lean into the recession talk. I'm seeing too many clients want to stay on the sidelines and fear this talk from the media not realizing that yes, they're common and two, we come out stronger [unintelligible] other end because we're so resilient. When it comes to the US economy as well, one number to keep in mind that I like to use $26.5 trillion. $26.5 trillion. What is that number? That's our total seasonally adjusted annual output GDP. There's no economy in the world as productive and resilient as ours. We have less than 5% of the world population yet we account for around 26% of global GDP. If that doesn't speak volumes about our ability to innovate and to reset and be resilient and dynamic in the face of multiple problems, I don't know what does. So, think of it that way. We're a superpower in so many industries whether it's agriculture, aerospace, entertainment, financial services, you name it on down the line. So, this economy to me is resetting post the pandemic and post the inflation problems that we've had and we're going to continue from there. Then the last part - short term, medium term, is the long term. When I say the long term, I'm really looking into the second half of this decade and believe it or not, it's coming up really fast. I think in the second half of this decade it's going to blow people away in terms of how this economy looks so much more different in terms of productivity, efficiencies, and still being the global leader that it is in all these various sectors. Just look at the AI debate, right? Who's leading that debate? The US companies are. We are. Renewables, electrical vehicles, charging stages, new bridges, roads, trains, you name it. There's a huge manufacturing renaissance coming down the pipeline with all this infrastructure spending, chips and science acts, IRA, a lot of this new dynamic capital is going to be deployed. You're going to start to see the fruits of that in the second half of this decade. What it means is more productivity, higher paying jobs, more affordability for the lower income classes. It's on down the line and I really truly believe that and I think we'll still be leading the rest of the world. The rest of will be catching up. So, think of it that way. So, kind of to wrap off kind of my three-dimensional lens. Short term - we got the debt ceiling elephant to deal with. That's going to pass very shortly but there's going to be some volatility. Medium term focus - uncertainty around the Fed and the recession call, but lean into the recession. Explain to clients what this actually means on the other side. Then long term - the second half of this decade it's going to be mind blowing in how different this economy is going to look when we get to the other side. So, what does that mean for portfolio positioning? Lauren Sanfilippo and myself wrote a piece a couple weeks ago. It's really about hard hats, hard assets, hard power. What do I mean by that? Hard hats - I'm talking about the infrastructure spending that's coming really in all 50 States, domestic and foreign production. Savita talked about this, Michael, Ethan, [unintelligible] across the whole top of the house. There’s an infrastructure spending coming here in the US for the rest of this decade that's akin to the 1950s, so think of it that way. A lot of spending coming down the pipeline, so hard hats, think industrials, anything that moves earth, digs up, shovels, you name it. Hard assets - minerals, metals, energy. If we're going to build out the infrastructure, we need a lot more copper, you name it. With EV same thing -minerals, metals. We need rare earth minerals, we need nickel, we need lithium, so we're very much still bullish on the hard assets albeit realizing some of these commodity prices have pulled back albeit the industrial side of the S&P is lagged a little bit here, but when you look further out 12, 24, 36 months, the best is yet to come. The last one – hard power. That's just the geopolitical realities of our time. The peace dividend is gone. Now it's about hard power. We see it in Europe, you're seeing it in Asia, and really if you track what's going on in Ukraine, we've gone from defensive posturing to now offensive posturing. These would be the weapons. Geopolitics between the US and China continue to boil. We'll see how that plays out, but nevertheless when you kind of step back, very much constructive on the hard power play vis-à-vis US large defense contractors. I know they've pulled back. They're going to pull back with the debt ceiling debate as well, but that's going to be an entry point for clients that do not have that exposure. So, to kind of wrap up for this week, we're looking at some significant big issues in washing the play out and they will play out. We still have in front of us the Fed June meeting and the shifting narrative towards higher rates potentially. Another rate hike we'll see. The recession call is still out there for sure, but keep in mind longer term on these pullbacks they are opportunities to invest in this great second half of this decade. As I said, it's going to be mind blowing. So that's it for my opening comments for today, May 25^th.

Operator:                   Please see important disclosures provided on this page.

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Joe Quinlan:              Good morning. This is the market update from May 22^nd. Joe Quinlan, Chief Market Strategist for the CIO office. I'm going to start with just kind of the market performance. Last week the S&P, the NASDAQ, and the Dow Industrial Average all posted gains and for the year, the Dow is up 1.7% total return, S&P’s up almost 10%, the NASDAQ doing fabulously at 26.6% year to date through the end of last week on Friday. Pretty good tone to the market overall. In particular, earnings - around 95% of the S&P is reported - the top and bottom line better than expected. Not as bad as most folks had feared when it came to the earnings and to the revenue growth, and that's given the market more or less a really good undertone for where we are today. It is obviously being led by big technology. They have the big bid out there. If you look, the biggest five companies of technology, they have a combined market cap of $8.7 trillion at the end of Friday. They now account for around 25% of the S&P 500 cap and roughly 80% of the S&P 500 gains this year has come from these five companies. So it has been a narrow rally, but we do expect more breadth as we dive deeper into this year. This year we talk about it's really about the fed and the economy. Let me just start with the really economy. The numbers from April leading into May - better than expected. Retail sales came in at 0.4%. Still growth. We saw that was all from the declines in February and March. So we're seeing the retail, the consumers start to come back. They're spending more on services rather than goods, but autos are also getting a boost. Autos is big when it comes to industrial production and you're seeing consumers finally going out and trading up or into their new cars or trucks, so automobile production is ramping up. When you look at the housing market, mixed numbers in terms of new home sales, permits starts, really the mixed picture. It's also a mixed picture when you look at manufacturing. Some slowdown there related to capital expenditures. So when you kind of step back the $26 trillion US economy is chugging along albeit our economists are still looking for that recession call beginning in the third quarter of this year. A lot of the recession call will rest with the fed. There's a 22% chance according to the latest numbers that the fed will raise rates in June. The odds are that the fed are on pause, but really kind of when you look across the landscape, the fed may be on pause but they're going to keep the fed funds rate elevated. That's the expectation/the consensus. So the work is not done albeit there could be a pause in June in terms of the next rate hike and the markets are working their way through that as we speak. Overseas, something is to note - the weakness in China, whether it's retail sales, factory activity, fixed asset investment, very weak numbers for April coming through and that's weighed on oil prices and some other commodities as well, so that's something to watch very carefully. Europe keeps chugging along, around 1% growth and nothing dramatic out there, but nevertheless, global growth is soft heading into the summer and we do think it's going to continue to remain soft because while the fed could be on hold, there's a lot of work in Europe to fight inflation. Inflation expectations, inflation itself is much higher in Europe than it is in the United States. So kind of when you step back, it's a constructive outlook albeit there’s sogginess to earnings yet to play out. The economy still kind of working its way through a very aggressive fed tightening cycle, fed’s on pause, earnings coming in better than expected and really, we got to step back and just see how the consumer plays into Q2 - Q3 because remember, the US economy 70% of GDP is consumption. The consumers - we're looking at a good labor market, solid labor market relatively speaking, you're still seeing income gains, less inflation biting into the real incomes of US consumers - that's going to be key in terms of like where we go from here. Clearly when you look at the earnings, when we look into the second half of this year, companies leveraged to the consumer or technology, particularly artificial intelligence, that seems where there's a lot of play, a lot of activity, a lot of optimism in terms of between now and next 12 months in terms of where we're headed. So to kind of wrap up, we do have one big nut out there I'm going to talk about in a moment, but the economy continues to chug along. Earnings are better than expect. Little weaker than expected out of China. Europe’s chugging along. Then the big issue/the elephant in the room is the debt ceiling debate and this is a tough call. The principles are speaking. President Biden came back early from the G7 [unintelligible] meet with the republican leadership. It’s a very tough call between now and the X date which is anywhere between early June to mid-June. We do continue to expect consensus on The Street that the debt ceiling will be raised. That’s number one. Number two, however, what's the fallout? What's the spending cuts? What’s the plan look like in the aftermath? Spending, tax receipts, tax increases, the revenue and spending side. So we're the markets are a little still very much on edge and very much focused on the debt ceiling debate and we're nearing the end game in terms of the two parties finding some solution, but I want to emphasize that we do expect the debt ceiling to be raised. It’s just how do we get there and we're now looking for a default. We're going to see some volatility between now and then, but I would urge investors – remember, the US economy - pretty resilient, pretty dynamic. Earnings better than expected. We're looking for slowdown ala recession in the second half of this year, but we're still seeing some opportunities to put money to work whether its equities and fixed income with the US bias. So I will end there. That's it for the market update for May 22^nd. Joe Quinlan from the CIO office. Thank you.

Operator:                   Please see important disclosures provided on this page.       

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Chris Hyzy:                Hey. Thanks, everyone, for joining this week's Street Talk Call. Special topic is the debt ceiling negotiations and timelines and with me today is Dan Clifton, the Head of Policy Research at Strategas Research and we're going to go through that in a lot more details in just a few moments. We might even touch on the upcoming primaries for the presidential election of 2024 at the end of the debt ceiling commentary. As it relates to just upfront on comments, I just want to hit three quick points here. We're coming out of earnings season. We're getting more data around inflation and jobs claims. We're getting more data as it relates to the consumer, but we're also seeing a growing trend in which corporate America is able to hold margins pretty steady. What is happening in earnings and sales right now is something that's not necessarily a surprise, but it is a little bit of a bloom for the positive side of the equation, and that bloom/what is occurring is a disconnect between prices coming down  at the producer level and prices coming down at the retail level. In other words, some of the higher cost inputs that some companies and some sectors had as pressures last year, particularly at the tail end of last year, supply chain pressures, etc. those are going away. So, the input costs for many companies are coming down. There's slightly lower volumes, but actual pricing power is not waning or fading at the sales end/at the retail distribution end versus the actual input cost. So, in other words, operating leverage is actually holding the line pretty well. That’s a very, very good sign. So it kind of confirms what we've long said which is a rolling recession. It hits the areas that were completely overbuilt during the pandemic. Coming out of the pandemic, a lot of those inventories were drawn down aggressively. Some were built back with input costs that were too high and then ultimately pricing power came and as volumes are coming down and pricing power is coming down, what we're noticing again is that the producer level, things like lumber costs, base metal costs, etc. even oil and gas prices coming down aggressively, you're seeing positive operating leverage, and that is across the board. What we haven't yet seen is this rolling recession leaves areas like manufacturing initially in housing when affordability became untenable and ultimately the low profitability areas shift into manufacturing, supply chain worries. We haven't seen it come fully into the services sector. We suspect that that is more of a fall/perhaps the latter part of this year type of occurrence, but again with the consumer having a much better balance sheet, the fact that home ownership in the United States today as it relates to equity in the home is much higher than it's been in many, many years, if not decades, and also ultimately the leverage in the system isn't there what it was in any time in the most modern era. So, all of this lends itself to the ability for the consumer to be more resilient. Now if the consumers’ more resilient and the corporations’ more resilient, what's happening in risk assets makes sense. We've been stuck in a range for the S&P 500. Obviously, a good portion of the gains have been dominated by the large mega tech areas, but so have the last 13 - 14 years. So, the trend really hasn't changed year to date. What we are noticing though is some of the defensive areas have become overvalued - classic sign that we're heading into a more defensive posture, but at the end of the day the last 12 months the S&P 500 is up some 5% - 6%, which if you looked at all the worries and concerns out there in the world including the debt sharing that we'll get to in just a moment, you wouldn't expect that, but here we are stuck in a range give or take 3850 - 4200. We've been stuck in this range bouncing around for quite some time. There seems to be a little bit of a wait and see type of approach and you can have that when you have cash yields at 5% and people are fine with that. So, we are still neutral fixed income, neutral equities according to our own benchmarks, and we believe that there will be three episodes between now and the end of the first quarter of next year. We've talked about this in terms of dollar cost averaging. One of them could actually be when the debt ceiling is raised. Not necessarily up ahead of it, it’s actually after it's raised and we'll address this with Dan as well in terms of how the treasury has to so-called re-liquefy its treasury general account and what that can do to reserves and liquidity in the market. We think that there will be pressure once the debt ceiling is raised and they'll have to actually increase their so-called coffers at the Federal Reserve. In other words, the treasury's checking account. So overall, want everyone to think about three things. In the short term, let's get through the debt ceiling. Let’s get through financial conditions which are likely to tighten further once we get through the debt ceiling. We'll hear from Dan on all the details as relates to that. Number two, the next timeline is we have to get through into the latter part of the mid part of the second quarter of next year and that's the bridge period. That's going from what was to what is about to be and what is about to be is an entirely new cycle driven by new catalysts that are driving change across the economy, not just at one vertical of the economy. More to come on that. We call it, “When the oceans collide in the era of rapid advancement,” so we'll talk more about that in future calls. Then finally in the long term there’s this notion of a new long term bull market. Everybody wants to know what's the driver of that? So, we just break it down simply, the driver of the next long term bull market is more about profitability and operating leverage and it's less about multiple expansion. So, in future calls we're going to talk about the catalysts that drive that and the good news is this - innovation, technology, and advancement is happening much quicker, higher velocity, and more impactful and all of that lends itself to an entire new era that wipes away, at least in our opinion, some of the big worries that are out there. It doesn't change the debt shelf, doesn't change the worries over interest costs, doesn't change the geopolitical equation, but in terms of how a company can be productive, it can change the landscape of jobs and it can certainly change the landscapes of productivity which ultimately drives long term growth and keeps inflation at bay. All of which is happening before our eyes. We’re at the beginning stages of that so in future calls we’ll talk more about that. Right now, we're going to switch directly to the debt ceiling concerns, the timeline, the details, what's going on day to day and no better person out there to discuss that with us other than Dan Clifton at Strategas Research. So, Dan, welcome as always. Let's get right to it. I'll hand it over to you. Tell us what you know right now, what you're looking for, and what the next week or two entails.

Dan Clifton:               Great. Well Chris, thank you and thank you to everybody for being on this call today. I want you to know that we're here to help in any way possible over the next couple of weeks. I'm sure you're getting a lot of client questions and we want to be of assistance to your efforts. There is a real framework change going on in Washington. It's not bearish. I do agree with many of Chris’ comments about innovation that's happening, but the monetary, fiscal, and geopolitical framework that we've had through 40 years have been altered. High inflation leads to higher interest rates, higher interest rates leads to higher net interest costs, and as you have both of those in monetary and fiscal issues beginning to develop, it begins to change the geopolitical landscape. So, investors need to adjust. The debt ceiling is the beginning part of this process that we're actually seeing play out. For the first time in 35 years the US now has a rising debt servicing cost. We've been able to cut taxes and increase spending and the debt servicing cost to increase and this debt ceiling deal is probably not going to fix much of that. So, this is the opening course. There are two goals that we are trying to solve for here. The first goal is to make sure that we get the debt ceiling up so that there's not a default. The second is to start providing some near-term austerity to get much of the excess of the Covid spending back to a normal process and begin to change the trajectory of the debt to GDP ratio so that the debt servicing costs ease. I tend to say that this is the opening course. Over the course of the next few years we are going to have to deal with some bigger austerity issues, particularly as we get to the end of 2025 and you have all of the Trump tax cuts expiring and issues are going to have to resolve about that. Where we stand today is actually one that is quite constructive. I don't want to be Pollyannaish about this. There are some hurdles and road bumps or speed bumps in the road that we're going to have to deal with over the next couple of days. I'm going to outline them for you. We have been fairly constructive that if the house passed the bill that raised the debt ceiling and cut spending, it would force a negotiation. That negotiation began two weeks ago or last week and that negotiation did not do very much. There are two main reasons for that. The first is that the people in the room were not decision makers and second, there were too many people in the room. I've become far more constructive this week when changes were made to the negotiating process with The White House on Tuesday. That room is now smaller and it is people who are trusted advisors of the president and of the speaker of the house. Historically this is how the process is built for deals to get done. It doesn't guarantee that a deal is going to get done, but it puts it on a much better trajectory to get this done. What is in front of us right now is an X date that continually shrinks in size. It's getting closer and closer. There was a belief for most of this year that we can get to June 15^th without having to raise the debt ceiling. A surge of corporate tax collections would come in. Then we get new extraordinary item power at June 30^th and that would allow us to go to late July or early August before we had to raise the debt ceiling. That is no longer the case. April tax revenues when most Americans pay their taxes got slaughtered and the most interesting development is that the main tax revenues have been far worse than budget forecasters have been associated with. So that's going to be true both at the Federal and at the state level and that rapid deterioration of Federal tax revenues is pulling forward the debt ceiling X date. Right now that date is set for June 1^st. We believe that they have a couple of extra days of cushion and could probably get to June 4^th or 5^th. Two weeks ago the government thought that they'd have $100 billion of extra money and that would carry us maybe a week or 10 days very close to that June 15^th deadline, but not enough to get us there. So that cushion that we've had has shrunk. What that has done counter intuitively has focused Washington and built in a new urgency level. The speaker of the house and the President of the United States. Are now treating June 1^st as the X date. Could be June 4^th, could be June 3^rd, could be June 5^th. Nobody really knows. It depends on the cash flow coming in, but for the purposes of this call, June 1^st is that X date and that's when negotiators are negotiating around. Why that's important - for a bill to get signed into law and June 1^st by President Biden, that deal needs to be announced on Sunday, meaning four days from now we need that deal announced. That would enable two days of drafting then posted on the house website. The house has a 72-hour rule before any bill can be considered. This stems from the fact that we get thousand-page bills and then vote on it six hours later when we know that nobody actually read those thousand-page bills. So now we have a cushion for that, 72 hours. That means earliest the bill can be voted on is on May 26^th. Interestingly, this was in our note this morning, the speaker of the house has come across the tape in the last half hour saying that he fully expects that this bill will be on the house for next week, which means he's getting bullish that we're going to get a deal over the course of this weekend. Once the bill clears the house, it will then be hand delivered over to the Senate on May 27^th and from May 27^th, it will take two or three days to work through the senate procedure, setting up a vote on May 30^th in the senate. That should be enough time for the senate to vote on a bill, enroll that bill, move it over to the White House, have the White House review it, and have the president signed that bill before 4:00 PM on June 1^st. So that's the timeline that we're operating from. It's also the signpost on whether we're making progress in the negotiations as well. I want to be clear that if there's an emergency, there are definitely safeguard mechanisms that could expedite the process, but you only do that if there is an emergency. So, I think about 2011. Chris and I used to talk a lot during the 2011 debt ceiling fight. We had a deal on a Sunday night and we had that bill passed within two or three days of that deal being announced. So, all that procedure that I just went through, we basically bypassed that, but you would need unanimous consent in the senate to waive those procedures. Judging from the comments of Bernie Sanders this morning and judging from the previous behaviors of Rand Paul, it's very unlikely that you're going to get that unanimous consent unless there's an emergency. So, we're sticking to the normal process to the June 1^st deadline and saying, “What are our benchmarks of a potential Sunday deal?” That’s where negotiators are very focused. They have been negotiating since Tuesday night since the White House meeting broke up. They’re focused on four very specific areas for this debt ceiling budget deal to be announced. The first is that they would rescind about $60 billion of Covid funding that is unobligated. I want to make a distinction this is not in the $350 billion that's already been obligated that will be spent. This is the $60 billion that we’ve allocated and they couldn't spend. Obviously, the public health emergency is over so why not just rescind that money? It is the low hanging fruit of the deal. It has the support of the White House now and it was in the Republican House Bill, so that is item number one. Item number two is the largest portion of this bill. It's called a cap on discretionary spending. Discretionary spending is one-third of the Federal budget. It is defense spending and non-defense spending. That's very different than Social Security, Medicare, and interest which is mandatory spending and makes up two-thirds of the budget. The 2011 debt ceiling deal would cut discretionary spending. Today, we're talking about something much less. We're talking about reducing the growth rate of discretionary spending. Discretionary spending is expected to grow at 2.5% per year for the next 10 years. The proposals being put forward. Could reduce that growth rate to 2% per year or you could see this year's discretionary spending levels just basically flat line next year and then a slower growth rate moving forward. Both of those proposals, however they decide to skin that, comes out to about $1 trillion over 10 years of savings and will be the major portion of this deal. Obviously, the defense stocks have been pricing this in since January 6^th since the Republicans elected McCarthy as speaker and you're starting to see some pressure in some of the healthcare areas that are affected by that. So, the market’s been very aware that this could be part of it and it is forming in that direction. The third is a little bit more controversial. It is what we call work requirements on transfer spending program. The Republican bill put work requirements on Medicaid, food stamps, and what we call [unintelligible], which is the old welfare if people knew it. The White House has ruled out no work requirements on Medicaid, no work requirements on food stamps, and so there may be a symbolic - in addition to work requirements on the tenant program, it’ll be relatively small. It could allow Kevin McCarthy to say that he got work requirements. It could allow the democrats to say that they prevented any substantive work requirements from going into effect. The fourth will be the hardest to get rid over the next few days because it is the most controversial and most undecided at this point. What the fourth area focuses on is expediting energy permitting reform. The republicans want to create a faster process to allow natural gas [unintelligible] to be cited. The democrats want a faster process for renewable energy projects, citing in particular transmission lines, that could actually amplify the tax credits that were put forward in the Inflation Reduction Act. We have been fighting over these provisions for a year. Democrats don't want fossil fuels. Republicans don't want the Federal government to have power over state transmission lines and there's never been any decision made. It could turn out that there is no decision made on this, that it doesn't make it in. Extremely rare to put extraneous policy measures that are not budget related on the debt ceiling bill, but I do think that this will get included. I do think it will get included for two very specific reasons. Most democrats are opposed to the spending cuts that are being put forward by these negotiations. They are going to need a policy win and that policy win is getting better renewable energy [citing]. It really eases the sting of some of these spending cuts and as I said before, I believe that this amplifies the initiatives that were put forward in the Inflation Reduction Act. For the republicans who cut spending by $4 trillion, most of those cuts are never going to make it into law. That means the republicans are going to have to vote on a bill with much smaller savings. The citing of energy, natural gas pipelines will actually ease the sting from there. So, I view the energy permitting language as a dessert and it makes it easier and sort of a way to kind of facilitate the process. The second reason - this has not been decided in a year and it hasn't been decided in a year because we haven't had a good reason to decide these issues. Now we have a hard deadline and that could force decisions and make everybody make their compromise. So, I would watch that. I think it's a very big deal in terms of what we would be doing for our energy infrastructure from an all the above approach and could wind up being one of the big winners out of this deal. Now, I just want to urge everybody – I meant projecting a level of confidence here. I want you to know that these are operating probabilities, but what I would argue is that there's probably going to be some near-term volatility in the next couple of days politically. The democrats are still talking about 14^th Amendment, minting coins, and discharge petitions. Those are not realistic options. The president understands that and the senate majority leader understands that, but there's just this level of denial here that there has to be spending cuts. I just want to be clear, this is everything we've done for the last 40 years. The democrats were able to use the debt ceiling to get spending increases out of President Reagan and President Trump and President Bush. The republicans were able to get spending cuts out of President Clinton and President Obama. George Herbert Walker Bush raised taxes, forced into raising taxes by the debt ceiling in 1990. So there really is nothing unusual about divided government adding budget measures to the debt ceiling. I think the president, who's been here for 45 years, understands that and that's why we're proceeding here, but for a while you're going to see a lot of hand wringing amongst the democrats and that is going to be questioned that even if there is a deal, can you get the votes for a deal? We believe that this deal will be bipartisan in the house, bipartisan in the senate. You have 130 republicans in the house, 100 democrats in the house. Every bill that passes the senate is going to need 60 votes in the US Senate. That means that you're going to need a combination of republicans and democrats, and I believe that the president, the speaker cut a deal, that Mitch McConnell and Chuck Schumer, Kevin McCarthy, Hakeem Jeffries will be able to build the vote and be able to get that vote for something to be able to pass. So I actually think in the next couple of days the news flow may argue different, but they will work through that and they should be able to get a deal through. Couple of key points that I'll make on this with respect to the debt ceiling is that we've changed our probabilities recently on whether this is going to be a one time shot long term debt ceiling increase or a two-step process. This is extremely important for what Chris referenced in how the treasury’s going to finance the deficit after the debt ceiling gets raised. I've been in the two-step camp where you get an ironclad top line agreement, raise the debt ceiling for two months, and then fill in the details and get a longer-term debt ceiling increase. I've received enormous pushback in Washington on that concept over the last couple of days. The focus of policymakers is to get this deal done and get it done immediately and so that we don't have to think about it until after the presidential election in 2024. The tight timeline - going to be hard to do particularly around the energy permitting legislation, but it would make it much easier for the treasury to be able to finance the deficit if they get this one-time long term shot to raise the debt ceiling. The reason why it’s critical - and it sounds wonky, but it's going to be very important - for the last six months the treasury has been spending down its bank account because it hasn't been able to raise debt. As that treasury spends down their bank account, they're taking money outside the banking sector and they’re putting it into the banking sector. It is providing a wonderful source of liquidity to financial markets. There's a very strong correlation between that liquidity entering the system and NASDAQ's relative performance to the S&P 500 growth versus value, the US dollar, and even Bitcoin. Again, I'm may not want to make a broad statement over two years of correlation data, but the TGA, the Treasury General Account, is a relatively new concept and it's having a big effect. As soon as the debt ceiling gets raised, that would quiddity stops coming into financial markets and that liquidity which is overpowering Jay Powell's QT means that QT will now become the dominant policy once the debt ceiling is raised. The treasury has got a big problem because $2.2 trillion of assets have moved out of the banking system into the reverse repos at the Federal Reserve. Overnight rate is just much better at those reverse repos and so the challenge for the treasury department is to be able to get their debt financed without going into the banking sector and using bank reserves, but to get that money out of reverse repos. The way to do that is to flood the market with short-term treasuries, T-bills, to try and get the interest rate higher than the overnight repo rate. The treasury will have far more flexibility to do that if they get this very big debt ceiling increase right off the bat that takes them through the presidential election and I think will be a source of big debate and constant watching once the debt ceiling is raised, but we overall think that there will be less liquidity just from the liquidity injections not happening. It would be a much bigger deal if we had to finance the debt out of bank reserve. That is a massive liquidity drain and it's one that we did in 2021 and it had a pretty negative impact on stocks. I don't think that is the base case, but it's something that we're watching very, very carefully. In terms of where we're headed from here, Chris, I would just argue that the bid and the ask between the two parties is not very far off. There are big differences on what the growth rate of discretionary spending should be and the length of time, but there's agreement that there's going to be a cap on discretionary spending. There is a difference between renewable energy and fossil fuels, but there's an agreement that we need to do energy permitting reform and there is an agreement on Covid funding. So, my sense is that when you see the bid and the ask spreads closing as you do in these negotiations, I do think that we're going to get a deal in the next couple of days. I wouldn't be surprised if it's Sunday or Monday and then that will set off some action in the house and senate. There will always be those ankle biters arguing that this doesn't do enough or it does too much, but it feels like the center is going to win out here and it’s likely we're going to get a debt ceiling. So I threw out a lot of information, probably best that I stop there. Be more than happy to dig into any type of questions that you may have moving forward.

Chris Hyzy:                Dan, great overview. Very specific. I do have one particular follow-up questions as it relates to short term debt ceiling right now. You addressed the potential options in terms of a short-term funding bridge versus getting this done for real and getting it through into the following fiscal year, but the question I have - is with all of your discussions in Washington, is there a growing understanding and a growing concern about the level of interest costs on all the debt? I know it's a longer-term question, but it is something that is now very real. Have you seen and an awareness pick up specifically on the sizable increase in the interest costs that simply continues to grow?

Dan Clifton:               Chris, I do not. It’s because there have been deficit scares in the past and they've turned out not to be an issue. The best way to think about this is that the frameworks are shifting here, Chris. So, the Fed couldn't recognize inflation because most people in charge had never seen inflation before. There's 1,000 PhDs at the Fed. Most of them have never seen inflation before. They didn't know how to deal with it and then we had inflation. The same thing is now happening with interest costs. I write extensively about interest cost. I know that once you hit 14% of interest costs - 14% of tax revenues that are going to interest costs, austerity kicks in. The financial markets begin to impose austerity on policymakers. Today we're at 12.7%. We will be at 14% in the next couple of months. When I talk about this, people's eyes glaze over. So, the risk here is that you basically say, “Oh okay, we avoided default. We did some modest spending cuts.” The rating agencies come out and do the math and say, “Hey you know what? We’re going to downgrade the US because your fiscal situation is terrible and the political environment is terrible,” right? I don't know if that's going to happen but those are the ways – nobody cares about that until you do and we're getting closer to that moment where we do because we've never been in a rising rate environment and a rising interest cost environment for nearly every elected official that's here in Washington, DC. The irony about this is that there are a couple who are here during that time and which was in the early ‘80s and President Biden was one of them. If you look at what happened in the ‘80s, Chris, it's so instructive of where we're going today. Ronald Reagan came in and he cut taxes so he's viewed a tax cutter but what \many people don't realize is that he raised taxes six years in a row after that tax cut. So, he had the big rates down, corporate and income but he was raising other tax rates and the most meaningful impact of that interest cost is that it began to squeeze out the entitlement programs, particularly Social Security. So, Congress created the commission, which might even be part of this bill this time, and they hired an unknown economist at the time named Alan Greenspan to lead what was called the Greenspan Commission. It set the stage to make Social Security solvent for the next 50 years. Now I tell you, what's 50 years from today? 1983 is when they did that bill, 50 years is 2033 and for the first time since the early ‘80s you have one portion of Social Security and one portion of Medicare that go insolvent within that budget window just as the Greenspan Commission envisioned. The interest cost is now starting to squeeze them out, squeeze out those entitlement programs, and it will eventually force Congress to quote, “Save Social Security,” at some point and you know what that means - higher payroll taxes and a longer retirement phase in of when your benefits kick in. It’s not going very well in France right now. So, this is a totally different environment and Washington just hasn't woken up to it because the old model of where we could do unlimited tax cuts and spending is what's dominating today.

Chris Hyzy:                Got it. Thank you. Let’s switch over to something that will come very quickly. It's not necessarily directly debt ceiling related, but what are the current thoughts about the primaries that we’ll all be watching and voting on come next year?

Dan Clifton:               Chris, I think this is going to be the most exciting election of our lifetime. I know most people are not excited about the election. I understand it. I spent 11 weeks traveling around this great country last election cycle and I was talking about the concept of a Trump versus Biden race. It didn't matter who you were, didn't matter what party you were, didn't matter age, what race, people would just look at me like, “God, I don't want that to happen,” okay? [Laughter] It was like the only thing everybody agreed on and so if you look at the consensus, that's where we are today. What I would argue just being on the ground, being with voters, being with clients, I would argue that both of their support is a little bit softer than the consensus is probably anticipating. Now, that doesn't mean that Biden's going to lose a primary. I think that's very unlikely. Joe Biden wants to be the nominee. He's going to be the nominee but we've been watching these Kennedy speeches, the RFK Jr. speeches and a lot of people just don't pay attention because he’s got views on vax that they may disagree with vaccines but when you watch his speeches, it's like Bernie Sanders and Donald Trump had a baby. It’s just this kind of raw anti-corporate populism that resonates really well with Bernie Sanders voters and Donald Trump voters when you watch it. The significance of that, Chris, is that it reminds me a lot of the 1992 republican primary. George Herbert Walker Bush was President, he was running for reelection, and he was challenged by the populist right of Pat Buchanan. Now as we all know, Pat Buchanan didn't win the race, but what he did was he started putting kinks in the armor of a sitting president that created two effects. The first is it allowed Ross Perot to run from the center and two, it dented the president enough that he eventually lost that re-election to Bill Clinton. So that's the risk for Biden, is that he faces this populism. Biden’s team, I give an enormous amount of credit for because they planned for this. This would be a lot worse if Iowa, New Hampshire were the first States for the democrats but they've changed the order. They have South Carolina, they have Georgia, they have Michigan going first and those are going to be much more positive states for the president where he can run up the numbers quickly and then kind of avoid that. So, it's a bit of a chess game that's going on there and then if the president doesn't run, it would be because his advisors are worried not about where the president is today or whether he can handle a campaign, it’s whether he can make it through the next four years where he'll be 86 years old at the end of his second term. If you're going to do this, you should plan on doing it for the whole term and I think that's the debate that's happening. For the campaign they have a whole list of surrogates. They really thought out how to do this and it's a pretty thoughtful operation that's running on that side. So, I still think that Biden will be the nominee. His risk is that he opens the door to a third party, which [unintelligible] talks about in a minute. Then you go over to the republican side. Wow. Wow. Trump is a steamroller. I think we forget how much of a steamroller Trump is. Ron DeSantis just had one of the greatest elections that I've seen. It looked like George W. Bush in 1998 even better and wins Florida, wins it in a landslide, wins Miami-Dade County. These are just unbelievable metrics. Trump saw it as a threat. Trump is doing exactly what he did in 2016 - take out the biggest bully in the race. 2016 it was Jeb Bush - then you play with all the marginal players after that. Trump is trying to take out Ron DeSantis and leave himself with a group of smaller people. I think it's a little bit early. I think the DeSantis team are really starting to get their footing. They had a great weekend in Iowa this weekend. They'll be in New Hampshire this week. They're starting to understand the dynamics of how to operate the machinery for a presidential campaign and they're doing a pretty good job of it. Obviously, DeSantis has moved further to the right as Trump has attacked him. Created some positions that are going to make it hard for him to win the general, but I would keep an eye on DeSantis. I'm not ready to rule him out like many people in Washington are. I'll tell you, I was very intrigued this morning by the release of the video of Governor Youngkin from Virginia. It is a national video. This is a governor who went to Taiwan three weeks ago. This is the only governor in America who released better than expected April tax collections because he planned for a 30% reduction in capital gains and the decline in tax revenues in New Jersey and Virginia are very similar, but one said they're going to go down more and didn't spend that money and the other one did. So, I think he's pretty serious about running for president although he's been playing coy. When you watch the video, you see him going to Taiwan, the way he's handling his fiscal management, he's setting himself up to run. The other candidates that I would keep a really close eye on is Tim Scott, the Senator from South Carolina and the republican leader on the Senate Banking Committee. He's got all the connections right now to be able to raise the money to be competitive and he will do really well in a republican primary. The key to this is there going to be one candidate or is there going to be eight? If there’s eight, there’s going to be a cannibalization effect and that's going to allow Trump to win with his 25% or 30% of the vote. The consensus today is correct and Trump wins and Biden wins, I fully expect that there will be a third-party challenge, may even be a unity ticket, one republican and one democrat. That movement to put ballot access on for the candidate has been in process for two years and there's money being raised for the process. What's interesting is there are people raising the money and doing the ballot work. They just don't know who the candidate is going to be right now. So that's sort of an “in case of emergency” and that's why I think the ‘92 comparison is so relevant today, is that there's very likely that we're going to have this weird cycle where a third party can come in there and disrupt the race a little bit and then particularly true if you get a Trump vs. Biden race. So, I hope I'm answering a question on that. We’re 18 months out, but the next president and the next Congress gets to decide what the income tax rate is going to be, what the estate tax rate is going to be, what the AMT rates going to be, what the state and local tax deduction is going to be because we’re going to have to deal with all of those issues by December 31, 2025 and it's going to be a major, major fiscal bill and one that sets the direction of fiscal policy in the United States.

Chris Hyzy:                Excellent. As always, Dan, that's a great place to end the upfront comments for today on the debt ceiling and all things around it including the timeline. Next week will get very, very interesting. The next couple of weeks will get interesting. We'll be on future calls to discuss it. Thanks as always, Dan. Have a great day.

Operator:                   Please see important disclosures provided on this page.

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