It has certainly been an interesting month. The near-term outlook for the

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1 Executive Summary by Brian Beaulieu A WORLD OF TRENDS It has certainly been an interesting month. The near-term outlook for the US economy improved in most respects. According to the final reading of US first-quarter GDP growth, the economy contracted during the first three months of the year. However, our advice is not to pay much attention to that data. Canada and Mexico are both showing signs of more solid growth, so all of North America looks to be on good footing. Europe is still seeing its economy gradually improve although the recovery is clearly not shared across all sectors. The UK, having successfully restarted its housing market, is looking at low inventories in some markets. Home Prices are heading higher, and as such, they are now planning to throttle back on the growth. Economic conditions in China are deteriorating although the official Industrial Production trend line in the chart below does not reflect this apparent reality. Brian Beaulieu CEO, ITR Economics weak. Our expectation of further easing in the 12/12 rate-of-change is unaltered. US Trends Looking Positive Looking more closely at the United States, one of the trends that has been providing some consternation is the deceleration in the Housing Starts trend that is not related to the tough winter months. The April data for Housing Starts allayed some of those fears. April rose 24.4% above a year ago. The industry is rebounding well from the winter. As further evidence, since the February low, the seasonal rise in activity of 24.1% is stronger than average based on the last years. However, note that while activity was stronger in April, some of the foundations of the housing market, such as Household Formation and Housing Afforability, are particularly 3 North America - China - Europe Industrial Production Total Retail Sales (adjusted for inflation) was 3.9% higher than the year-ago figure. We are maintaining that consumer spending will end the year around 2.% higher than 13. There are no overt downside problems for Nondefense Capital Goods New Orders either. The latest employment data shows that the number of jobs created in May was sufficient to indicate that real economic growth is occurring. The Unemployment Rate remained relatively low North America at 6.1% (not seasonally adjusted data). The China - Teenage Unemployment Rate lowest since late Western Europe Eastern Europe 8; the kids at home should have an easier time finding a job this summer. (Continued next page) JUNE /12 Rates-of-Change United Kingdom -3 ' '1 '2 '3 '4 ' '6 '7 '8 '9 ' '11 '12 '13 '14 '

2 China s Negative Indicators Once you dig deeper beyond the headline data, China is not looking good. Foreign Direct Investment is a bellwether for how the rest of the world views China, and Investment contracts are down.2% over the last three months compared to last year. Manufacturing Exports (an essential lifeline for China) are down 3.7% for the last three months compared to one year ago. Residential Construction Completed going back over the last 12 months is 3.8% below the same period last year. These are worrisome numbers that could play a hand in the global slowdown in growth that we are forecasting through mid-1. Positive European Developments Europe is holding up well despite issues stemming from Ukraine. Retail Sales are up, Industrial Production is rising, and the EU Composite Leading Indicator is suggesting more upside activity is on the way. The EU Purchasing Managers slipped a little, but at 2.2, it remains in positive territory. The biggest concern (besides the unevenness of the recovery) from one economy to the next and one segment to the next is the ongoing disinflation. The trend is of sufficient concern that the European Central Bank moved its deposit rate from zero to -.1%. While noteworthy for the negative interest rate, it is questionable if such a small move will have the desired effect of stimulating inflation, freeing up credit for smaller businesses, and lowering the value of the euro. That s a lot of activity to expect for such a small change. Historical S&P Trends One major short-term fear that we have is still clearly unresolved - that being the ongoing ascent in the S&P. As discussed on the Stock Prices (page 7 in the Financial Module), the sheer duration of this trend is becoming problematical. Measured off the 9 low (this low correlates to the end of the Great Recession), there are only two precedents out of 29 prior rising trends that relate to what we are going through in this cycle. One precedent is and the other is Both of these rising trends didn t end with a correction ; they ended with a crash. If that happens following the current rising trend, our general economic forecast of no-recession until either 18 or 19 would likely turn to dust. We are still doing research to see if, this time, monetary policy or the form of liquidity could make for a different outcome; however, we are always mindful of the perils of finding reasons why it will be different this time. Long-term Concern over Future Inflation A major long-term issue that we think business leaders and investors should be aware of is the threat of future inflation. The chart to the left shows that there has been a pick up in the Producer Price (PPI) trend of late, but the trend Money Stock PPI 1 Money Stock to Producer Price (All Commodities) 2 Data Trends right now is not worrisome. Such little gain in the PPI rarely makes a noticeable impact on the 1 Consumer Price. What can be gleaned from the chart is that over the longer run, the rate of inflation, as measure by this PPI, will tend to keep pace with the rise in money in circulation. The timing relationship certainly isn t immediate; it could be years before circumstances are ripe for the monetary base to lay the ground work for more inflation. We think it likely that other factors will fall into place beginning in the second half of Money Stock (MZM) PPI 1 that will lead to yet another period when the PPI trend will seek to catch up to the monetary base. The inflation threat is real, but it is also latent for now. '91 '92 '93 '94 '9 '96 '97 '98 '99 ' '1 '2 '3 '4 ' '6 '7 '8 '9 ' '11 '12 '13 '14 '1 6 JUNE 14

3 ITR Trends ITRCurrentData Production Wholesale Trade Consumer Prices New Orders Medical Retail Housing Financial Soft Landing Foreign Nonresidential Construction Hard Landing About ITR Trends The ITR Trends compares the current cyclical status of major benchmarks of macroeconomic activity as they move through this business cycle and into the next. Think of the Trends as a train with cars. The majority of the cars have gone through a soft landing for the cycle. Please note that not all of the remaining cars will go down into a hard landing. Many are likely to pass through a low between Phase C and Phase B without going into Phases D and A. This is the essence of the soft landing we are projecting for this business cycle. Summary The Financial, Housing, and Retail Sales are leading the economy in Phase C, Slower Growth, of the business cycle. Production and New Orders are approaching the top of the business cycle with an expected third quarter peak. Nonresidential Construction and Consumer Prices join the Foreign benchmark, Medical, and Wholesale Trade in Phase B, Accelerating Growth, of the business cycle. Phase A: Recovery RECOV 12/12 is rising and the data trend is either heading toward a low or is in the early stages of recovery. This is the first positive phase of the business cycle. Phase B: Accelerating Growth CCELERATINB 12/12 is rising above, data trend is accelerating in its ascent, and growth is occurring above year-ago levels. This is the second positive phase of the business cycle. Phase C: Slower Growth SLOWER G 12/12 decline is in place, data trend is decelerating in its ascent or has stopped its rise, but it is still above last year. This is the first negative phase of the business cycle. Phase D: Recession RECESSD 12/12 is below, data trend is in recession at levels below the yearearlier level. This is the final phase and the second negative phase of the business cycle. 8 JUNE 14

4 ITR Leading Indicator and Economic Forecast ITR Leading Indicator Unchanged in May ITRCurrentData 1 ITR Leading Indicator 1 The ITR Leading Indicator was unchanged in May from the April value. The overall trend of mild decline persists in the ITR Leading Indicator, signaling that the overall economy in the US (as measured by US Industrial Production) will slow in its pace of growth in the latter half of 14 and into early 1. US Industrial Production increased 3.1% during the year ending in April, and internal indications suggest that the rate-of-ascent will mildly accelerate as we head into the second half of the year. All of the components of the are contributing to the growth, but the Mining Production component of the is providing the most lift with annual Production coming in 6.% above the year-earlier level. Utilities Production is slowing to a more normal pace after the harsh winter weather rapidly increased demand in late 13 and early 14. Manufacturing Production is growing at a relatively stable annual rate of 2.8%. Our outlook for the US economy is unchanged. Expect mild deceleration in late 14 and early 1, but activity will reaccelerate by mid-1 and through year-end USIP 12/12 ITR LI Raw 7 '8 '9 ' '11 '12 '13 '14 US Total Industrial Production 12MMA Forecast Range 12MMA Actual Forecast Period 12MMA Forecast Result Dec Mar Jun Sep Dec Mar Jun Sep Dec JUNE 14

5 ITRCurrentData US Total Industrial Production, 7=, N.S.A. 1 Rate-of-Change MMA Forecast 12MMA 3MMA Data Trend /12 Forecast Range 12/12 3/12 ' '11 '12 '13 '14 '1 ' ' '11 '12 '13 '14 '1 ' US Total Industrial Production inched upward and currently stands 3.1% above one year ago. Indications are for further growth in Production, albeit at a slightly slower rate in the second half of 14, going into 1. We expect an overall positive cycle over the next 18 months, a reduction in growth rate, not a recession. The current rise in the Production data trend represents broad based growth in the US economy in terms of both industrial sectors and geographic regions. Manufacturing Production and Mining Production both show accelerating growth. Utilities Production is flat since last month but still 2.% above one year ago. The Federal Reserve s Beige Book shows growth in all 12 Fed Districts. Seventeen out of 18 industries surveyed for the May ISM Purchasing Managers reported expansion. Unemployment remains at 6.1% and the Total Industry Capacity Utilization Rate slipped to 78.6%, indicating lingering slack in the economy. Non-farm Employment finally regained its pre-recession level with million non-agricultural jobs in the US (Total Employment has yet to recover, next page). At 77 months, this is the longest time to reach this recovery milestone of any post-wwii recession. Along with the recent downgrade to official estimates of total potential output and the persistent gap in labor and capital employment rates, this suggests that permanent, structural degradation of the US economy has occurred in recent years. ITRManagementNote Slower growth over the next year means no more automatic gains. Focus on differentiating yourself and your competitive advantage. ITREconomicSnapshot Current Phase B ACCELERATING GROWTH Forecast % % Highlights Slower growth in 2H14 Broad based growth tempered by lingering slack in the economy Data Link Ask An Analyst JUNE

6 TrendsReport MANUFACTURING ITRCurrentData Metalworking Machinery New Orders Billions of Dollars, N.S.A. 4 3 Rate-of-Change 4 3 Bils $ 11 Data Trend 12MMT Forecast 12MMT 3MMT 37.7 Bils $ /12 Forecast Range 12/12 3/12 ' '11 '12 '13 '14 '1 ' ' '11 '12 '13 '14 '1 ' Metalworking Machinery New Orders has transitioned in to Phase C, Slower Growth this month, with annual New Orders stalling and the 12/12 rate-of-change dropping sharply. In its first month, the 12/12 declining trend is the second strongest on record. Indications are that the decline will continue through the end of this year. For the year overall, we expect a 2.% decline in annual New Orders. The decline will be brief however, with recovery in the second half of 1 and annual New Orders approaching the current level by year-end. The Gardner Metalworking Business was flat in May, confirming our outlook that accelerating rise in this New Orders segment is over for now. The index is still in positive territory though, so a steep drop in total Machinery New Orders is not indicated at least in the near term. The use of metal additive manufacturing (3-D printing) for prototyping and manufacturing is growing by leaps and bounds, up 7.8% year-over-year at the end of 13. Though this is still a small part of this market, taking advantage of the opportunities presented by emerging technologies is an important part of long-term strategy for success. Manufacturers are increasingly relying on these machines for rapid development and overcoming the capital expense of new technology by bringing new product and component designs to market faster. ITRManagementNote Beware linear operational budgets as growth has slowed, but with recovery on the way next year, drastic retrenchment is not in order. ITREconomicSnapshot Current Phase C SLOWER GROWTH Forecast % % Highlights Transition in to Phase C, Slower Growth Mild decline this year, recovery in 1 Data Link Ask An Analyst 6 JUNE 14

7 TrendsReport FINANCIAL ITRCurrentData Consumer Price (Consumer Inflation), =, N.S.A. 4 2 Rate-of-Change MMA Forecast 12MMA 3MMA Data Trend /12 Forecast Range 12/12 3/12 ' '11 '12 '13 '14 '1 ' ' '11 '12 '13 '14 '1 '16 2 In April, the Consumer Price (CPI) increased 2.% from the same month one year ago, the fastest rate of growth in nine months. On an annual average basis, consumer inflation is accelerating at a 1.% clip a seemingly benign number. Our expectation is that the rate of inflation will move in a fairly horizontal fashion through the end of the forecast in 1. While higher food prices have been receiving a lot of attention in the press, overall food price inflation remains mild. On an annual average basis, CPI Food is sitting at 1.4%, essentially in line with the rate of inflation for the economy as a whole. That is not to say that there are not pockets of inflation in the food sector. Beef, Pork, Poultry, and Dairy prices are all posting strong year-over-year gains. Additionally, drought conditions in California could impact fruit and vegetable prices. In total however, these products constitute a small percentage of the total CPI Food basket. Clothing prices are having a moderating effect on inflation. The annual average CPI Apparel is just.% above last year. The slower pace of price ascent for clothing is likely to continue as cheap foreign imports flood the country. Imports now account for roughly 98% of the US clothing market. ITREconomicSnapshot Current Phase B ACCELERATING GROWTH Forecast % % ITRManagementNote Invest in efficiencies, whether they are related to your people, processes, or software, while inflation and interest rates remain low. Highlights Consumer inflation jumps in April but is still mild Apparel prices have moderating effect on overall inflation Data Link Ask An Analyst 12 JUNE 14

8 Data Methodology ITR Economics Moving Total/Moving Average Moving totals/averages are used to smooth out the volatility inherent to monthly data. Monthly Moving Total (MMT) vs Monthly Moving Average (MMA): Totals are used for things where is makes sense to add the data together. For example, units sold, or total dollars spent. There are times when it is desirable to calculate a monthly moving average instead of a total. Averages are used when the data cannot be compounded such as an index, percent, price level, or interest rates. 3MMT or 3MMA: A three-month moving total (3MMT) or average (3MMA) is the total (or average) of the monthly data for the most recent three months. Three-month moving totals (3MMT) or averages (3MMA) illustrate the seasonal changes inherent to the data series. 12MMT or 12MMA: A twelve-month moving total (12MMT) or average (12MMA) is the total (or average) of the monthly data for the past 12 months. The 12MMT (A) removes seasonal variation in order to derive the underlying cyclical trend. It is also referred to as the annual total or average. Rate-of-Change A rate-of-change figure is the ratio comparing a data series during a specified time period to the same time period one year ago. Rates-of-change are expressed in terms of the annual percent change in an MMT or MMA. Rates-of-change reveal whether activity levels are getting progressively better or worse compared to last year. Consecutive rate-of-change illustrates and measures cyclical change and trends. ITR Economics three commonly used rates-of-change are the 1/12, 3/12, and 12/12, which represent the year-overyear percent change of a single month, 3MMT, and 12MMT (respectively). A rate-of-change above indicates a rise in the data relative to one year prior, while a rate-of-change below indicates decline. Definition of an An index is a statistical measure of percent change from a base value in a dataset. The base value is equal to. Any reading above indicates a percentage gain above the base value and any reading below indicates a percentage decline from the base value. For example: an with the base year 7 means that the year 7 is. A reading of 7 indicates a 7% gain over the base year. A reading of 94 means activity is 6% below the base year level. JUNE 14

9 Four Phases of a Business Cycle ITR Economics Phase RECOVA A: Recovery 12/12 is rising but remains below zero, and the data trend is either heading toward a low or is in the early stages of recovery. This is the first positive phase of the business cycle. CCELERATINB Phase B: Accelerating Growth 12/12 is rising above zero, data trend is accelerating in its ascent, and growth is occurring above year-ago levels. This is the second positive phase of the business cycle. Phase A Management Objectives Phase Late A - Recovery: 1. Positive leadership modeling (culture turns to behavior) 2. Establish goals: tactical goals which lead to strategic achievement 3. Develop a system for measurement and accountability re:#2 4. Align compensation plans with #2 and #3. Be keenly aware of the BE (Break Even) point and check it regularly 6. Judiciously expand credit 7. Ensure distribution systems are ready to accommodate more activity 8. Review and uncover competitive advantages 9. Invest in customer market research (know what they value). Improve efficiencies with investment in technology and software 11. Start to phase out marginal opportunities 12. Add sales staff 13. Build inventories (consider lead time and turn rate) 14. Introduce new product lines 1. Determine capital equipment needs and place orders 16. Begin advertising and sales promotions 17. Hire top people 18. Implement plans for facilities expansion 19. Implement training programs Phase B Management Objectives Phase Early B - Growth: 1. Accelerate training 2. Check the process flow for possible future bottlenecks 3. Continue to build inventory 4. Increase prices. Consider outside manufacturing sources if internal pressures becoming tight 6. Find the answer to What next? 7. Open distribution centers 8. Use improved cash flow to improve corporate governance 9. Use cash to create new competitive advantages. Watch your debt-to-equity ratio and ROI 11. Maintain/pursue quality: don t let complacency set in Phase Late B Early C - Prosperity: 1. Stay in stock on A items, be careful with C items 2. Consider selling the business in a climate of maximum goodwill 3. Penetrate new selected accounts 4. Develop plan for lower activity in traditional, mature markets. Freeze all expansion plans (unless related to what is next ) 6. Spin off undesirable operations 7. Consider taking on subcontract work if the backside of the cycle looks recessionary 8. Stay realistic beware of linear budgets 9. Begin missionary efforts into new markets. Communicate competitive advantages to maintain margins JUNE

10 Four Phases of a Business Cycle ITR Economics Phase SLOWER C: Slower GRCGrowth 12/12 decline is in place but remains above zero, data trend is decelerating in its ascent or has stopped its rise, but it is still above last year. This is the first negative phase of the business cycle. Phase C Management Objectives Phase Late C - Warning: 1. Begin work force reductions 2. Set budget reduction goals by department 3. Avoid long-term purchase commitments late in the price cycle 4. Concentrate on cash and balance sheet. Reduce advertising & inventories 6. De-emphasize commodity/services in anticipation of diminishing margins 7. Weed out inferior products (lose the losers) 8. Encourage distributors to decrease inventory 9. Identify and overcome any competitive disadvantages. Make sure you and the management team are not in denial 11. Cross train key people 12. Watch Accounts Receivable aging 13. Increase the requirements for justification of capital expenditures 14. Evaluate vendors for strength 1. Manage backlog through pricing and delivery, try to fill the funnel Phase D: Recession RECESSD 12/12 is below zero and declining, data trend is declining to levels below the year-earlier level. This is the second negative phase of the business cycle. Phase D Management Objectives Phase Early D - Recession: 1. Continue force reduction 2. Reduce advertising be very selective 3. Continue to avoid long-term purchase commitments 4. Review all lease agreements. Increase the requirements for justification of capital equipment 6. Eliminate all overtime 7. Reduce overhead labor 8. Combine departments with like capabilities and reduce management 9. Select targets of opportunity where price will get the business.tighten credit policies increase scrutiny 11. Look for opportunistic purchases 12. Grab market share as your competitor dies Phase Late D - Recession / Early A - Early Recovery 1. Prepare training programs 2. Negotiate union contracts if possible 3. Develop advertising & marketing programs 4. Enter or renegotiate long-term leases. Look for additional vendors 6. Capital expenditures & acquisitions considered in light of market-by-market potential 7. Make acquisitions use pessimism to your advantage 8. People will be scared lead with optimism and can do attitude 22 JUNE 14

11 Checking Points ITR Economics '8 '9 ' '11 '12 '13 3/12 12/ Positive Checking Points 1. 3/12 reaches a low 2. 3/12 passes above the 12/12 The rate-of-change is making the transition from the previous cycle s decline to rise in the current business cycle. Checking points #1 and #2 reflect this activity /12 reaches a low The onset of business cycle rise is observed. 4. 3/12 crosses about the % line. 12/12 crosses above the % line The entry of the cycle into its steepest part of the rise is with checking points #4 and #. Negative Checking Points 6. 3/12 reaches a high 7. 3/12 passes below the 12/12 Checking points #6 and #7 indicate that the business cycle is making the transition from rise to decline 8. 12/12 reaches a high Business cycle decline begins with checking point # /12 crosses below the % line. 12/12 crosses below the % line The entry of the cycle into its steepest part of the decline is with checking points #9 and #. JUNE