Chevy Chase Trust - Investment Update, Fourth Quarter 2018

Investment Update: Third Quarter, 2009

This is a quarterly update of economic conditions and investment strategy.

Economic Conditions

We expect positive GDP in the last half, 2009 and into 2010 as a consequence of the powerful
measures in the Federal stimulus package. The stimulus includes a massive increase in Government
spending, tax incentives, and a central bank monetary policy unprecedented in its aggressiveness.
Inventory rebuilding also will add to the growth in GDP. Nevertheless, GDP, for the whole of
2009, will likely be minus 2% or worse. Our early look at 2010 is about 2% positive, not a good
showing coming out of such a deep recession.

Holding back a healthy rebound is another eighteen months of inventory overhang in residential real estate; an accelerated downturn in commercial real estate; excess capacity in the labor market and in plant and equipment; and excessive debt levels in important sectors of the U.S. economy.

An analysis of debt levels is key to a considered position on whether the economic improvement brought by the Federal stimulus will be sustained. It is widely reported—and we agree—that the multi-decade, unrestrained expansion of credit in the U.S. must be reversed and that it will take a good many years to accomplish this at a cost, among other things, of a reduced rate of GDP growth. This means pressure on the
rate of growth in incomes, i.e., pressure on disposable income that supports personal consumption expenditures, almost 70% of GDP. Expanding consumer debt to increase purchases is off the table. Quite the reverse, consumer credit is contracting at a pace not seen since 1991, as consumers try to bring debt levels down to a manageable size. For now, saving is a consumer goal.

We believe that a new consideration in U.S. economic recoveries is taking place—a behavioral economics phenomenon—a sustained growth in the rate of saving. In past recoveries, when economic activity picked-up, spending increased as consumers felt more confident of their future. This increased economic activity led to more hiring in a selfreinforcing cycle. We do not believe that U.S. consumers have the same level of confidence as in past recoveries because of concern about their pensions and the levels of Federal, State and local debt, including future liabilities. Japan and China have high sustained saving rates because, in the former, citizens are concerned about the high Government debt and what that means for future taxes; and in the latter, citizens know that pension plans are inadequate or non-existent. U.S. citizens are not likely to behave differently; consequently, growth should be less than in previous recoveries.

Investment Strategy

It is clear to us that in a time of limited resources, eventually, priority will be given to our most pressing needs. We have commented on the investment implications of this in previous reports to you. We believe that we are in the early innings of investment performance of many “high priority” securities, despite their positive recent performance and recognition in the media. These include companies involved in infrastructure
improvements, energy development, water and food issues, and electrical transmission overhaul. Our work continues to focus on assembling the best list of companies from a world-wide population and establishing sensible entry prices.

Our fixed income portfolio focuses on short-term, high quality securities. (Strategic purchase of municipal bonds of longer maturities for taxable accounts is an exception.) The size of future Government debt funding in the next five years is breathtaking and, in our view, will significantly increase interest rates across all maturities and types of debt. The ten year Treasury bond, the new benchmark, yielding under 3.5% may experience an enormous drop in value if the ten year interest rate becomes 6%, which we forecast within the next several years. Other bonds will follow the lead of the ten year, resulting in a popping of the bond bubble.

In summary, the worst of the recession is behind us but the economic recovery will be uneven and anemic. We believe this condition will draw interest to “high priority” needs and related securities.

Chevy Chase Trust, October, 2009