Third Quarter 2012 Reflections: Economy and Capital Markets – continued

Please refer to important disclosures on page 5. 1

Third Quarter 2012 Reflections: Economy and Capital MarketsPrepared: October 19, 2012

Overview

Capital markets generated mostly positive returns for investors during the third quarter. This occurred even as challenges to the global economic environment led two major central banks to engage in further quantitative easing. Most major economies slowed, some even to the point of slipping into a recession.

Manufacturers scaled back their capital spending programs in response to concerns about:

• Economicslowdownandongoingdebt crisis in Europe

• SignsofslowingeconomicgrowthinChina

• FearsabouttheimpendingU.S.fiscalcliff(acombination of scheduled spending reductions and expiring tax cuts)

Evenwithsignificantcentralbankinitiativestoeasemonetary policy, inflation pressures ebbed around theworld.AwelcomebrightspotfortheU.S.wasimprovement in the housing market. Homebuilder confidenceroseasactivitybegantoincreasefromsteeply depressed levels.

Securitiesmarketsweredecidedlymoreupbeatasrisk assets surged in the third quarter. Investors who were not sitting on the sidelines were rewarded in a variety of sectors:

• Commoditiessurged11.5%,asmeasuredbytheS&PGSCI.Performancewasbuoyedbygainsinenergy, precious metals and grain prices.

• Stockswerestrongacrosstheglobe.TheMSCIAll-CountryWorldIndexgained7%,emergingmarketstocksincreased8%,andU.S.stocks,asmeasuredbytheDowJonesTotalStockMarketIndex,rose5.6%.EvenwithEurope’songoingproblems,theMSCIEuropeIndexreturned9%for the quarter.

• Foreignrealestategained9.5%,althoughU.S.RealEstateInvestmentTrusts(REITs)experiencedadifficultquarterastheDowJonesU.S.SelectREITIndexdropped0.4%.

• Bondsgenerallyperformedwell.KeybenchmarkssuchastheBarclaysU.S.AggregateandtheBarclaysMunicipalBondIndexrose1.6%and2.3%respectively.Creditriskwasrewardedashigh yield corporate debt and emerging market debt outpaced the broader indices.

GlObal ecOnOmy and POlicy

AsdatashowedaslowingoftheU.S.economicrecoveryinthethirdquarter,theU.S.FederalReserve(Fed)andEuropeanCentralBank(ECB)bothcommittedtofurtherquantitativeeasing(QE)measures.InSeptember,theFedannouncedadditional monetary accommodation, following its

Situation Analysis

1

a s c e n t . u s b a n k . c O m

Third Quarter 2012 Reflections: Economy and Capital Markets – continued

Please refer to important disclosures on page 5. 2

initial QE1 and QE2 programs. This was dubbed by someas“QEEternity.”TheFedindicateditwouldpurchase $40 billion of mortgage-backed securities each month until the outlook for labor markets improves materially. This policy appeared to enjoy initial success in driving down mortgage rates and helping spur a housing recovery.

markets continue to react Favorably to Quantitative easing

Sources:StrategasResearchPartners,Bloomberg.

TheactionbytheFedcameafterECBPresidentMario Draghi announced a plan to make unlimited purchases of sovereign debt in the secondary market. This plan is subject to the issuing countries being admitted into one of the programs designed to help deal with their excessive debt burdens. Objectives of the plan include correcting the significantinterestratedisparitiesamongEuropeanCurrencyUnionmembersanddispellingthenotionof a eurozone breakup. This program has been initially successful. Yields on ten-year bonds issued bySpain,ItalyandGreecedeclined0.50%to2.00%.

Worldwide economic growth appeared muted in the thirdquarter.IntheU.S.,GrossDomesticProduct(GDP)grewatanannualizedrateofjust1.3%inthesecondquarter.GDPintheeurozonedeclined0.7%over the quarter, its second decline in three quarters. Underlyingdatawasalsomodestlynegative.The

GlobalPurchasingManagers’Indexdeclined or slowed for most major economies, including theU.S.andChina.Inflationremainedlow,evenmoderatingsomeintheU.S.,ChinaandEurope. TheU.S.unemploymentratemanagedtofall belowthe8%mark,whileEurope’semploymentmarket deteriorated.

Positive news was limited, but one of the most encouragingsignscamefromtheU.S.housingmarket. The market remains well below its peak levels,buthomeprices,asreportedbytheFederalHousingAdministrationandtheS&P/Case-ShillerIndex, moved into positive territory in year-over-year measures. Housing starts and building permits stretched to post-recession highs and new and existing home sales continued to recover from their lowest levels. Housing represents just a small part oftheoverallU.S.economy,butimprovementinthissectorisimportanttoconfidenceandasignofrecoveryfromthefinancialcrisisthatwasdrivenbyexcessive mortgage debt.

improving Housing industry is vital to economic Growth

Sources:FactSet,NationalAssociationofHomeBuilders(NAHB)–WellsFargoHousingMarketIndex;data:January2000-September2012

2008

S&P

500

Inde

x Le

vel

2007 2009

QE1

2010 2011 Sep 132012

1600

1400

1200

1000

800

QE2 QE3Operation

Twist

80

70

60

50

40

30

20

10

020102009200820072006200520042003

Hous

ing M

arket

Index

Leve

l

200220012000 2011 Sep2012

Third Quarter 2012 Reflections: Economy and Capital Markets – continued

Please refer to important disclosures on page 5. 3

markets: risk On

Even though economic data was generally disappointing in the quarter, investor appetite for risk appeared to blossom. Markets climbed the proverbial “wall of worry” as stocks across a broad spectrum of the globe gained momentum. After a relatively flat July, investors appeared to see hope in expectations for an easing of monetary policy. Europe and emerging market nations were the strongest performers.

markets may Have Overly discounted the european debt crisis

Source:FactSet

Equities: The valuation of markets, as evidenced by price-to-earnings(P/E)multiples,hasincreasedandis supported by global central bank activity, despite a decline in earnings expectations for 2012. At best, this pace of improvement may remain operative for anotheryear,butnotindefinitely.Webelieveearningsestimates may still be too high looking out into 2013. Even in this challenging environment, dividends for theS&P500reachedanall-timehighinthethirdquarter. The list of companies paying dividends toshareholdersforthefirsttimeisgrowingandnow includes the market behemoth, Apple. Others areraisingpayouts,suchasan8%increasefromGeneralMills.YetthepayoutratiofortheS&P500

asawhole(dividendspersharedividedbyearningspershare)is29%belowitsten-yearaverage,sotheremayberoomforfuturedividendgrowth.Still,dividendyieldsonstocksoftheS&P500average2.05%,outpacingtheyieldonboththebenchmarkU.S.TreasurynoteandthediversifiedBarclaysU.S.AggregateBondIndex.

Fixed Income:Bondsalsoperformedwellascentral bank easing compressed yields, especially for risky debt. Investors hungry for higher yields than what were available from government-issued debt increased their exposure to credit risk. Yields on ten-yearU.S.Treasurysecuritiesremainedalmostunchanged from the beginning to the end of the quarter,at1.62%,buttherewassignificantvolatilityinbetween.TheBarclaysU.S.AggregateBondIndexgained1.6%overthequarterandhighyieldcreditsroseanother3%.Inthecurrentinterestrateenvironment, bonds are likely to continue to generate modest returns.

Commodities: Commodities were strong during thequarterdueinlargeparttoadroughtintheU.S.which pushed food prices higher and increased fears of a Middle East conflict leading to higher oil prices. Thegrainsindexjumped17%,butgavebacklargergains by late in the quarter as damage to crop yields was lower than expected. Energy prices moderated inSeptemberasinvestorfocusturnedtoconcernsof a global economic slowdown that could temper demand.Goingforward,theoutlookforcommoditiesis more modest, but as is often the case, volatile. Sloweconomicgrowthmaylimitpricegains.TheMiddle East remains unpredictable. The struggle over Iran’sdesiretoexpanditsnuclearcapabilitiescouldresult in a conflict, which would likely lead to a spike in oil prices. That appears to be the biggest wild card in the commodity markets today.

1,250

1,200

1,150

1,100

1,050

1,000

950

900

MSCI

Europ

e Ind

ex Pr

ice Le

vel

Oct 152012

Jan2011

Oct2010

Jan2012

Third Quarter 2012 Reflections: Economy and Capital Markets – continued

Please refer to important disclosures on page 5. 4

OutlOOk

In the closing months of 2012, more policy risks areonthehorizonastheU.S.dealswithitsfiscalcliff and the eurozone struggles with its debt crisis and the economic fallout from it. On the positive side, most corporations are healthy, maintaining low inventory levels and high cash reserves. China and other emerging market nations appear serious about providing more economic stimulus. China announced attheendofthethirdquarterthatitwouldadd0.5%toGDPperyearforthenextfouryearsthroughincreased infrastructure spending. Another plus is thattheU.S.consumerappearstobeinreasonablecondition. Household debt has been reduced, the employment environment is slowly improving and personal incomes are rising again.

Markets will be affected by ongoing uncertainty inthefourthquarter.Europe’sstrugglesremainunresolved,withdebtissuesinGreece,SpainandItalytakingcenterstage.Keybenchmarksforresolutionofthecrisis,includingfiscalunionandasingle banking authority, seem far off in the future. IntheU.S.,uncertaintysurroundingthepresidentialelectionandfiscalandtaxpoliciesthatcouldchangedramatically in early 2013 are issues for investors that could affect performance in the coming months.

improving confidence could make the Fiscal cliff a temporary issue

Source:StrategasResearchPartners

2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

$800

$700

$600

$500

$400

$300

$200

$100

$0

-$100

-$200

Amou

nt o

f Fed

eral

Fis

cal S

timul

us($

in b

illio

ns)

Third Quarter 2012 Reflections: Economy and Capital Markets – continued

5

NoTADEPoSIT NoTFDICINSURED MAYLoSEVALUE NoTBANKGUARANTEED

NoTINSUREDBYANYFEDERALGoVERNMENTAGENCY

imPOrtant disclOsures

Thiscommentarywaspreparedonoctober19,2012andtheviewsaresubjecttochangeatanytimebasedonmarketorotherconditions.ThisinformationrepresentstheopinionofU.S.BankWealthManagement.Sinceeconomicandmarketconditionschangefrequently, there can be no assurance that the trends described here will continue or the forecasts will come to pass. It is not intended toprovidespecificadviceortobeconstruedasanofferingofsecuritiesorrecommendationtoinvest.Notforuseasaprimarybasisofinvestmentdecisions.Nottobeconstruedtomeettheneedsofanyparticularinvestor.Notarepresentationorsolicitationoranoffer tosell/buyanysecurity.Investorsshouldconsultwiththeirinvestmentprofessionalforadviceconcerningtheirparticularsituation.The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness.U.S.Bankisnotresponsibleforanddoesnotguaranteetheproducts,servicesorperformanceofthirdpartyproviders.

Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for investment. The S&P 500 Index is an unmanaged, capitalization-weighted index of 500 widely traded stocks that are considered to represent the performance of the stock market in general. The Dow Jones U.S. Total Stock Market Indexrepresentsthetop95%oftheU.S.stockmarketbasedonmarketcapitalization.TheMSCI All Country World Index is designed to measure the equity market performance of developed and emerging markets. The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets. The MSCI Europe Index is designed to measure the equity market performance of the developed markets in Europe. Barclays Capital Aggregate Bond Indexmeasurestheinvestmentgrade,U.S.dollar-denominated,fixedratetaxablebondmarket,includingTreasuries,government-relatedandcorporatesecurities,mortgage-backedsecurities, asset-backed securities, and commercial mortgage-backed securities. Barclays Capital Municipal Bond Indexiscomprisedoffixedrate, investment grade, tax-exempt bonds with maturities of one year or more. The S&P GSCI is a composite index of commodity sector returnsthatisbroadlydiversifiedcrossthespectrumofcommodities.TheDow Jones U.S. Select REIT Index measures the performance of publicly traded REITs and REIT-like securities.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investinginvolvesspecialrisks,includingforeigntaxation,currencyrisks,risksassociatedwithpossibledifferenceinfinancialstandardsand other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity,prepayments,earlyredemption,corporateevents,taxramifications,andotherfactors.Investmentindebtsecuritiestypicallydecrease in value when interest rates rise. The risk is usually greater for longer term debt securities. Investments in lower rated and non rated securities present a greater risk of loss to principal and interest than higher rated securities. Investments in high-yield bonds offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstancesmayadverselyaffectabondissuer’sabilitytomakeprincipalandinterestpayments.Themunicipal bond market is volatile andcanbesignificantlyaffectedbyadversetax,legislativeorpoliticalchangesandthefinancialconditionoftheissuersofmunicipalsecurities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes, butmaybesubjecttothefederalalternativeminimumtax(AMT),stateandlocaltaxes.Therearespecialrisksassociatedwithaninvestment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, andtheimpactofadversepoliticalorfinancialfactors.Investmentsinreal estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates, and risks related to renting properties(suchasrentaldefaults).

©2012U.S.Bancorp(10/12)