Market Snapshot

September 2010 Liz Ann Sonders Senior Vice President, Chief Investment Strategist Charles Schwab & Co., Inc.

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The Bear Case

Debt bubble has shifted from private to public sector globally Double-dip chatter elevated Heightened volatility/high-frequency trading/flash crash Anemic jobs growth Deflation risk Faltering real estate recovery US leading economic indicators likely peaked Chinas leading economic indicators peaked last fall Government intervention (rising taxes, protectionism & regulation) Confidence crisis Hindenburg Omen

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The Bull Case

Strong growth in emerging (& some developed) economies Low borrowing costs Pent-up demand (consumer & business) Wall of worry is back with a vengeance Credit markets on the mend; improving bank loans Steep yield curve Healthy corporate profits & productivity Record high corporate cash (nearly $2 trillion) Record positive spread between corporate cash & capital spending Sharp rebound in M&A activity Reasonable valuation Tame inflation
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Growth Slowdown or Meltdown?

Double-Dip Not Signaled by Leading Indicators
OECD US Composite Leading Indicator 108 106 104 102 100 98 96 94 92 90 1965 108 106 104 102 100 98 96 94 92 90 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 1970 1975 1980 1985 1990 1995 2000 2005 2010

US

OECD Composite Leading Indicator

OECD Area

As of 6/10. Green-shaded areas indicate periods of recession. Current recession based on Sonders assumption of June 2009 end date. See

4 last slide for definition of recession. Source: FactSet, National Bureau of Economic Research (NBER), Organization for Economic CoOperation and Development (OECD). (0810-5555)

US Leading Indicators Rolling Over

But Not Yet Signaling Double-Dip Recession
Leading Economic Index (y/y % change) 20 15 10 5 0 -5 -10 -15 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

Improving - average workweek - vendor performance - new orders-capital goods

Stable - new orders-consumer - stocks - interest rate spread

Worsening - unemployment claims - building permits - money supply - consumer expectations

As of 7/10. Green-shaded areas indicate periods of recession. Current recession based on Sonders assumption of June 2009 end date. See last slide for definition of recession. Source: The Conference Board, FactSet, National Bureau of Economic Research (NBER). (0810-5555)

Coincident Indicators Not Signaling Double-Dip

Industrial Production Showing Greatest Strength
Coincident Economic Index (y/y % change) 8 6 4 2 0 -2 -4 -6 -8 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

1) real manufacturing & trade sales: strong & worsening 2) industrial production: strong & improving 3) personal income less transfer payments: fair & stable 4) payrolls: fair & stable
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As of 7/10. Green-shaded areas indicate periods of recession. Current recession based on Sonders assumption of June 2009 end date. See last slide for definition of recession. Source: The Conference Board, FactSet, National Bureau of Economic Research (NBER). (0810-5555)

GDP Improves Then Falters

Residential Investment & Inventory Pops Unsustainable
4Q08 30 Q/Q annualized % change 20 10 0 -10 -20 -30 -40
Business Investment Consumer Spending Residential Investment Exports Federal Gov't Spending State/ Local Gov't Spending

4Q09

2Q10

Inventory Investment: change in inventories added 0.6 percentage points to 2Q10 & 2.8 percentage points to 4Q09 vs. subtraction of 2.3 percentage points from 4Q08.
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Source: Bureau of Economic Analysis. (0810-5555)

Monetary/Fiscal Policy Affects Stock Market

Stimulus is WaningFed Halts Exit Strategy
50 NDR Real Monetary, Fiscal & Exchange Rate Policy Index 40 30 20 10 0 -10 -20 1974

NDR Policy Index

1/31/1974-7/31/2010 12-Month Change in Policy Index

1978 1982 1986 1990 1994 1998 2002 2006 2010

Dow Jones Annualized Gain 14.5% 7.5% 1.5%

12-Month Change in Policy Index

40 30 20 10 0 -10 -20 -30

> 8.8 -9.4 8.8 < -9.4

Policy Easing = Bullish

Policy Tightening = Bearish -40 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010

As of 7/31/10. Real Monetary, Fiscal & Exchange Rate Policy Index is: Real M2 Money Supply (year-to-year change) plus Real Federal

8 Expenditures (12m total, year-to-year change) less Real Federal Receipts (12m total, year-to-year change) less Real Broad Index of the
Foreign Exchange Value of the Dollar (year-to-year change). Source: Ned Davis Research, Inc. (NDR). (0810-5555)

Inflation Not a Threat With No Velocity of Money

Until Then, Deflations the Bigger Threat
2,200 Monetary Base ($, billions) 2,000 1,800 1,600 1,400 1,200 1,000 800 2007 10 M2 to Monetary Base Ratio 9 8 7 6 5 4 3 2007
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Monetary Base

Fed flooded system

2008

2009

2010

Money Multiplier

But velocity of money remains depressed

2008

2009

2010

As of 8/10. Source: FactSet, Federal Reserve. (0810-5555)

Positive Yield Spread Predicts No Double-Dip

Fed Trying to Flatten Curve to Stimulate Lending?

1.0 Probability of US Recession Predicted by Treasury Spread 0.8 0.6 0.4 0.2 0.0 1960

1970

1980

1990

2000

2010

10 States twelve months ahead. Green-shaded areas indicate periods of recession. Current recession based on Sonders assumption of June
2009 end date. Source: Federal Reserve Bank of New York. (0810-5555)

As of 7/10. Chart uses the difference between 10-year and 3-month Treasury rates to calculate the probability of a recession in the United

Money Supply Growth Extremely Low

Main Trigger for QE2 Talk

M2 Money Supply (y/y % change)

14 12 10 8 6 4 2 0 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

11 As of 7/10. QE=quantitative easing. Green-shaded areas indicate periods of recession. Current recession based on Sonders assumption of
June 2009 end date. Source: Ned Davis Research, Inc. (0810-5555)

Loan Supply/Demand Fundamentals Improving

First Positive Cross in 6 Years
Tightening Standards for C&I Loans Reporting Stronger Dem and for C&I Loans 100 Large & Medium Banks 80 60 40 20 0 -20 -40 -60 -80 1990 1994 1998 2002 2006 2010

12 As of 3Q10. C&I=commercial & industrial. Source: FactSet, Federal Reserve.

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Credit Conditions Healthier

But Lending Activity Remains Subdued
2 Bloomberg US Financial Conditions Index 0 -2 -4 -6 -8 -10 -12 Jun-07 Lehm an Shock

Dec-07

Jun-08

Dec-08

Jun-09

Dec-09

Jun-10

The BFCI combines yield spreads and indices from the short-term debt markets, equity markets and bond markets into a single normalized index.
13 below the average of the 1992-2008 period. Source: Bloomberg.
As of 8/27/10. Y-axis values are z-scores which represent the number of standard deviations that current financial conditions lie above or (0810-5555)

Claims Drop Lost Some Momentum

But Still Better Than Two Prior Jobless Recoveries

Current Initial Unemployment Claims (4-week average) 650 600 550 500 450 400 350 300 Nov-08 Feb-09 May-09

1983

1992 & 2002 Average

Aug-09

Nov-09

Feb-10 May-10

Aug-10

14 Current (11/7/08-8/20/10). 1983 (5/14/82-3/30/84). 1991 and 2002 (average of 11/2/90-9/18/92 and 5/25/01-4/11/03). Source: Department
of Labor, FactSet. (0810-5555)

Debts Growth as GDP-Driver

Over $5 of Debt to Produce $1 of GDPNot Sustainable!

Diminishing Returns from Debt-Financing by Decade Date Range 12/31/49-12/31/59 12/31/59-12/31/69 12/31/69-12/31/79 12/31/79-12/31/89 12/31/89-12/31/99 12/31/99-12/31/09 Decade Change in Debt ($, billions) 337.6 752.1 2,785.2 8,562.8 12,550.0 26,939.2 Decade Change in GDP ($, billions) 248.0 491.3 1,654.9 2,922.3 4,026.0 4,846.1 Debt/GDP 1.36 1.53 1.68 2.93 3.12 5.56

15 Source: Ned Davis Research, Inc.

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Public Sector Takes Borrowing Lead

While Fed Became Lender of Last Resort
Private Sector Total US Borrowing ($, billions) 2,500 2,000 1,500 1,000 500 0 -500 -1,000 1968 1,250 Total Lending ($, billions) 1,000 750 500 250 0 -250 -500 1968 Public Sector

Borrowing

1974

1980

1986

1992

1998

2004

2010

Foreign

Federal Reserve

Lending

1974

1980

1986

1992

1998

2004

2010

16 As of 1Q10. Four-quarter moving average applied to data. Source: FactSet, Federal Reserve, MacroMavens.
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90% Debt/GDP = Threshold Above Which GDP Suffers

US Federal Debt Presently 93%
Real GDP Growth as Level of Government Debt Varies Select Advanced Economies (1790-2009) Central (Federal) Government Debt/GDP Below 30% Average Median # of Observations 3.7 3.9 866 30% - 60% 3.0 3.1 654 60% - 90% 3.4 2.8 445 90% and Above 1.7 1.9 352

Select Emerging Market Economies (1900-2009) Central (Federal) Government Debt/GDP Below 30% Average Median # of Observations 4.3 4.5 686 30% - 60% 4.1 4.4 450 60% - 90% 4.2 4.5 148 90% and Above 1.0 2.9 113

17 As of 1/7/10. Source: Growth in a Time of Debt by Carmen M. Reinhart and Kenneth S. Rogoff.
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GDPs Strength Has Dissipated

As Debt Growth Has Surged
180 Nominal GDP (10-year % chg) 160 140 120 100 80 60 40 1960 Total Credit Market Debt as % of GDP 400 350 300 250 200 150

GDP
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Credit Market Debt

100 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

18 As of 1Q10. Source: Bureau of Economic Analysis, FactSet, Federal Reserve.

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Bond Yields & Stock Prices Positively Correlated

Typical of Deflation Risk Eras
Monthly % Changes in S&P 500 and 10Y Bond Yields (rolling 10-year correlation) 0.4 0.3 0.2 0.1 0.0 -0.1 -0.2 -0.3 -0.4 -0.5 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Since 1990s: excess supply from emerging markets tips world toward deflation, sending correlation up

Correlation surged at onset of deflationary 1930s

Correlation moved up in 1950s after post-WWII inflation finally broken

19 As of 7/10. Source: The Leuthold Group.

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How Have Stocks & Bonds Fared Relative to History?

Stocks Reverted While Treasuries Remain Extended
Previous Cycles 115 110 S&P 500 105 100 95 90 85 -12 -10 -8 -6 -4 -2 0 Months Previous Cycles 110 Long-Term Treasury TR 108 106 104 102 100 98 96 94 -12 -10 -8 -6 -4 -2 0 Months
20 As of 7/10. Based on economic expansions between 1926-2010. Previous cycles are historical medians. TR=total return. Source:
Ned Davis Research, Inc. (0810-5555)

Current Cycle One year after start of econom ic expansion

S&P 500

+2

+4

+6

+8

+10

+12

Current Cycle

10y Treasuries
One year after start of econom ic expansion

+2

+4

+6

+8

+10

+12

Equity Fund Flows Negative

While Bond Fund Flows Soar
800 US Equity Mutual Funds Net New Cash Flow ($, billions) 600 400 200 0 -200 -400 1993
800 US Bond Mutual Funds Net New Cash Flow ($, billions)

Equities

1995

1997

1999

2001

2003

2005

2007

2009

Bonds
600 400 200 0 -200 1993

1995

1997

1999

2001

2003

2005

2007

2009

21 As of 6/10. Data based on 36-month sum. Source: Investment Company Institute (ICI), ISI Group.
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Risk-Aversion Up Again as Investors Flee Back to Bonds

Current Month (7/10)
Cash, 24%
Cash, 45%

Record High Cash (3/09)

Stocks & Stock Funds, 41%

Stocks & Stock Funds, 52% Bonds & Bond Funds, 24%

Bonds & Bond Funds, 14%

Record High Bonds (5/10)

Cash, 24%

Record High Stocks (3/00)

Cash, 15% Bonds & Bond Funds, 8%

Stocks & Stock Funds, 51% Bonds & Bond Funds, 25%

Stocks & Stock Funds, 77%

22 (savings accounts), and cash investments (CDs, money market funds). Source: American Association of Individual Allocation Survey (19872010). (0810-5555)

As of 7/10. For purposes of American Association of Individual Investors' Asset Allocation Survey, cash is defined to include cash products

Longer-Term, Reversion to Mean for Stocks/Bonds?

Nearly Unprecedented 20-Year Outperformance by Bonds
16% S&P 500 vs. 10-Year Treasuries (20-year trailing total return) 12% 8% 4% 0% -4% 1926

1Q09 Low thru 2Q10 S&P 500 TR: +25.4% (ACR) 10-Year Treasury TR: +7.7% (ACR)

1935

1944

1953

1962

1971

1980

1989

1998

2007

Five Years Later S&P 500 TR: +33.8% (ACR) 10-Year Treasury TR: +4.6% (ACR)

Five Years Later S&P 500 TR: +23.1% (ACR) 10-Year Treasury TR: +1.6% (ACR)

23 TR: total return. ACR:: annual compound rate of return. As of 2Q10. Source: Bloomberg, The Leuthold Group.
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Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. We believe the information obtained from third-party sources to be reliable, but neither Schwab nor its affiliates guarantee its accuracy, timeliness, or completeness. The views, opinions and estimates herein are as of the date of the material and are subject to change without notice at any time in reaction to shifting market conditions. Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance. Examples provided are for illustrative purposes only and not intended to be reflective of results you should expect to attain.

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Definitions
Indexes are unmanaged, do not incur management fees, costs and expenses (or "transaction fees or other related expenses"), and cannot be invested in directly. The Dow Jones Industrial Average (DJIA, The Dow) is a price-weighted average of 30 actively traded blue chip stocks, primarily industrials and is the oldest and most widely quoted of all the market indicators. The S&P 500 Index is a capitalization-weighted index of 500 stocks from a broad range of industries. The component stocks are weighted according to the total market value of their outstanding shares.

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Terms
Asset Allocation - The strategy of spreading your investment funds across categories of assets such as stocks, bonds and cash investments to help offset risks and rewards, based on your goals, time horizon and risk tolerance. Ned Davis Research (NDR) Crowd Sentiment Poll - Shows perspective on a composite sentiment indicator designed to highlight short- to intermediate-term swings in investor psychology. It's based on seven different individual sentiment indicators in order to represent the psychology of a broad array of investors. Recession - As per National Bureau of Economic Research (NBER), a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

26 2010 Charles Schwab & Co., Inc. All rights reserved. Member SIPC (0810-5555)