1Since 1895. Member SIPC and NYSE.

Outlook & Opportunities

Terry SandvenChristian Heitzman

July 2007

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Mid-Year Review & Outlook

Overview

• Performance• Interest rates• Inflation• Housing• Earnings

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Mid-Year Review & Outlook

Recap of First Quarter Outlook

• First quarter Outlook– Pro-growth thesis remains intact.

• Inflation will remain contained.• Economic expansion will continue, albeit at a slower rate.• Fed is not likely to move until second half of 2007; should sub-prime deterioration continue, next move is likely to cut; Fed is not under any immediate pressure to change its stance.

• Bonds and stocks will likely trend within a relatively narrow trading range, with an upward bias.

• Biased toward a pro-growth economy, driven largely by favorable employment conditions.

• Mid-Year Outlook– Largely the same as the first quarter.

• Evidence of some global inflation.• Fed may not move in 2007.• Equities are likely to outperform bonds in the second half of 2007.

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Performance

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PerformanceSeasonality

AVERAGE S&P 500 MONTHLY PERFORMANCE

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC

Jan. 1950 to April 2007 Jan. 1975 to April 2007 Jan. 1995 to April 2007

Data Source: Ibbotson Associates and FactSet Research Systems, Inc.

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Interest RatesSecular Change?

• The 10-year Treasury topped 5.0% for the first time since July 2006 before peaking at 5.31%.

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Interest Rates

U.S. Treasury Yield Curve

• Yield curve has flattened.

4.7

4.8

4.9

5.0

5.1

5.2

3Mo 6Mo 2Yr 5Yr 10Yr 30Yr3Mo 6Mo 2Yr 5Yr 10Yr 30Yr3Mo 6Mo 2Yr 5Yr 10Yr 30Yr3Mo 6Mo 2Yr 5Yr 10Yr 30Yr

1 Year Ago3 Months Ago1 Week Ago09-Jul-07

Source: FactSet Research Systems Inc.

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Inflation

Consumer Price Index (CPI)

• On an annual basis, CPI increased 2.7% in May versus 2.6% in April; core prices rose 2.2%.

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Inflation

Personal Consumption Expenditures (PCE)

• Core PCE increased 1.9% in May, down from 2.0% in April.

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Inflation

Fed Funds Versus CPI

• Adequate spread between fed funds and the CPI is arguably intact, suggesting that the Fed’s monetary policy will remain unchanged.

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Inflation

CRB Commodity Index

• Showing weakness, or at least is pulling back from recent highs.

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Inflation

Institute for Supply Management (ISM)

• Both ISM manufacturing and non-manufacturing are reflecting growth.

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HousingPending Home Sales of Existing Homes

• Pending sales of existing homes, a leading indicator because it tracks contract signings, continues to trend downward.

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Housing

New Home Sales

• New home sales continue to decline.

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Housing

Existing Home Sales

• Existing homes sales continue to trend downward.

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Housing

Delinquencies

• Housing—subprime deterioration—remains a predominant concern.

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Housing

Conclusion• Too early to conclude that housing has

bottomed; the housing environment remains challenging.– Distinction between “weak” versus “collapse”– Predominant view and evidence suggests potential

for further weakness.– Company results:

• Home Depot cut its annual profit forecast, citing the slumping U.S. housing market.

• Sears Holdings said its second quarter profit may decline by as much as 46%.

• D.R. Horton said it will report a third quarter loss after orders declined 40%.

• Implications and impact on consumer spending remain of concern.

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Earnings

S&P 500 Earnings Projections

• S&P 500 earnings growth is expected to modestly accelerate in 2008.

• Valuations are reasonable.

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Earnings

S&P 500 Earnings Projections

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Earnings

S&P 500 Valuation Levels (July 2007)

97 98 99 00 01 02 03 04 05 06

14x

16x

18x

20x

22x

24x

26x

28x

800

900

1000

1100

1200

1300

1400

1500

Price (Right)FY1 Price/Earnings Range (Left)Average (Left)

S&P 500 Index (Operating Basis) (SPX)

Data Source: First Call Estimates

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Conclusion

Outlook

• Pro-growth thesis remains intact, driven largely by favorable employment conditions and earnings outlook.– Core U.S. inflation will remain contained; global growth

and foreign interest rates seem biased toward further upside.

– Economic expansion will continue, albeit at a slower rate.

• Housing, company earnings and employment are key.– Fed is not likely to move until the fourth quarter, if at all

in 2007.– Adequate liquidity, increased merger and acquisition

activity, and attractive valuations present a favorable backdrop for equities to outperform bonds.

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The Fed Stays The Course

• We believe, and Fed Funds Futures corroborate the idea, that the Fed will be on hold through the balance of the year.

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Credit Markets

• Sub-Prime woes continue to dominate credit markets

• We don’t know the extent of the damage

• Credit spreads are moving out• Caution is still warranted

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Rates And The Curve

•Two stories here – domestic and global

•Domestic story is continued economic expansion versus the housing drag

•Global story is focused on other central banks raising rates and the need for a market adjustment in US rates to continue to attract capital

•Both stories at this juncture seem to point toward mild upward pressure on US rates

•A risk to this view is a major sub-prime event spurring a flight to quality

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The Muni Market

•Increased supply matched by new market participants

•Spreads are tighter, but could tighten further as new markets are assimilated

•International demand is present and increasing

•Judicial issues on the horizon, but not impacting the market as yet

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Final Thoughts

•Rates have a modest bias upward, but there are overhanging fears of sub-prime fallout

•We appear to be in a new trading range – 5 year notes above 5.05% seem attractive

•Credit instruments still seem rich versus the risk, but are adjusting

•The muni market continues to evolve and become more dynamic – we believe that this is and will continue to be positive and we remain constructive on munis.

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