Robert T. McGee, Director of Macro Strategy & Research U.S. Trust, Bank of America Private Wealth Management Joseph P. Quinlan, Managing Director & Chief Market Strategist U.S. Trust, Bank of America Private Wealth Management
HIGHLIGHTS •• ECB policy raises recession risk. •• The U.S., China and Japan remain the world’s top manufacturers. •• Developing nations are cautiously directing their savings into tangible assets.
ECONOMIC OUTLOOK1 Robert T. McGee
European Rescue Plan TRIES TO STOP Contagion As we expected, European governments decided that aggressive action was needed to stop the spreading instability in financial markets. European Union finance ministers agreed on a three-part package consisting of (A) 720 billion euros of loans and guarantees to help sovereign financing; (B) a package of European
Central Bank (ECB) initiatives to support sovereign debt markets; and (C) additional austerity measures to bring soaring country debt levels under control. The equity markets were initially impressed by the much biggerthan-expected size of the package.
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An additional measure announced in the latest rescue plan that does help in this regard is the reactivation of dollar swap lines between the Federal Reserve and other central banks, most notably the ECB. These worked quite well during the late 2008 crisis when short dollar positions were causing a scramble to get greenbacks that was driving the U.S. currency’s foreign exchange value sharply higher. More recently, as the Greek debt crisis escalated, European banks’ branches in the U.S. were paying increasing spreads over U.S. banks’ funding costs. These renewed swap lines can be used to mitigate that upward pressure on European banks’ dollar-funding costs. In fact, recent Fed data show the ECB drew on its renewed swap line in the first week.
While we believe that the measures taken are likely to solve the developing contagion problem by backstopping the European banks, which are the ultimate conduit of contagion into the broader global financial system, the plan is inadequate to solve the fundamental problem plaguing Europe’s economy and the euro. That’s because the ECB is stubbornly resisting adopting “quantitative easing.” In fact, the ECB overnight rate has remained at 1%, unlike the U.S. federal funds rate, which was cut to zero. Quantitative easing refers to central-bank actions to provide additional reserves to the banking system beyond the level necessary to keep rates near zero. The ECB has refused to go as far as the Fed or the Bank of England to address the deflation threat. As a result, the deflation threat is still growing in Europe, a process that will make austerity measures to rein in government debt self-defeating, as Japan has learned over the past two decades. Tight monetary policy retards economic growth and shrinks the tax base, making tax revenues fall. Efforts to raise tax rates and cut spending just exacerbate the down spiral once deflation has made it self-reinforcing. This is why the Federal Reserve and the Bank of England adopted more proactive, anti-deflation or reflation policies, including quantitative easing. Like the ECB, the Bank of Japan (BOJ) also resisted aggressive anti-deflation efforts. It was almost ten years into Japan’s two lost decades before the BOJ tried quantitative easing. At that point, stagnation and deflation were already well entrenched. Japan’s government debt-to-gross domestic product (GDP) ratio is the highest of any major economy because getting more tax revenues out of a stagnant economy is like squeezing blood out of a turnip.
How do we know the ECB is too tight? Exhibit 1 shows the difference between the U.S. Treasury 2-year note rate and the overnight federal funds rate over the past several decades. Recessions are shown in shaded regions. Recessions are preceded by tight money policies that are evident when the overnight rate is higher than the two-year rate. That makes the difference plotted in Exhibit 1 negative. A negative Exhibit 1 spread is one of the best predictors of recession. Exhibit 1 — Yield Curve Leads Cycle EXHIBIT 1: Yield Curve Cycle (2-Year Treasury Note YieldLeads Minus Fed Funds Targe Rate, %)
2-year Treasury Note Yield minus Fed Funds Target Rate (%)
The disappointing feature of the European bailout package is the ECB’s intent to “sterilize” the liquidity injected into the banking system under the new Security Markets Program, whereby national central banks purchase public- and private-sector securities to support the debt markets of the peripheral countries, like Greece. While this intervention will support the peripheral debt markets, sterilizing its impact on the monetary base perpetuates the “too tight” liquidity situation in the European banks.
Source: Federal Reserve Board/Haver Analytics Source: Federal Reserve Board/Haver Analytics. Data as of 4/30/2010 Data as of April 30, 2010. \\advjob\agency jobs 2009\G3 Projects 2009\GWIM\CMO\TM CMO Charts 2010-05-17a
Conversely, as the exhibit shows, the overnight rate falls below the two-year rate when a recession is over. In fact, the recession won’t end until monetary policy reduces the overnight rate below longer-term rates. That’s because banks borrow at short-term rates to lend at longer-term rates. If short rates are higher than long rates, lending stops.
capital market outlook 
Tight credit is reflected in an inverted yield curve. Exhibits 2 and 3 contrast the yield curves of the U.S. and Germany over the past few years. As the Greek debt crisis began to creep into money markets early this year, the German yield curve inverted, reflecting tighter bank lending conditions as interbank markets began a slow freezing process. In stark contrast, the U.S. curve has remained positively Exhibit 2 sloped.
The ECB’s decision to “sterilize” members’ bond purchases shows a bigger concern about inflation than about deflation. Markets are saying the ECB has it backward. This is not surprising, but it is disappointing because it means Europe is likely to follow Japan into stagnation unless this tight policy is reversed. While we have expected Europe to lag behind in this recovery, tight ECB policy generally and an inverted yield curve specifically mean that there is a significant risk of a double-dip in the Eurozone. Economic growth in the U.S. is running close to 4% so far in this recovery. Europe’s growth was less than 1% in the first quarter. This was partly due to bad weather, but it also shows fundamental weakness.
2-year Treasury Note Yield minus Fed Funds Target Rate (%)
Part of the problem is that there is little pent-up demand in Europe’s biggest economy. German consumers did not experience a housing or consumption boom during the last expansion. As a result, household spending held up relatively better during the recession. Government programs to stimulate car buying did cause a spurt in demand there. However, it was on top of fairly normal consumption levels and therefore most likely borrowed from future purchases.
Source: Federal Reserve Board/Haver Analytics Source: Reserve Board/Haver Analytics. DataFederal as of 4/30/2010
Data as of April 30, 2010.
Exhibit 3 \\advjob\agency jobs 2009\G3 Projects 2009\GWIM\CMO\TM CMO Charts 2010-05-17a
EXHIBIT 3: German Yield Curve Back in Recession Mode Exhibit 3 —Germany GermanGovernment Yield CurveDebt Back in Recession Mode (2-Year Yield Minus European Central Bank (2-Year Germany Government Debt Yield Minus European Central Bank Refinancing Rate, %) Refinancing Rate, %) 3
2-year German Government Debt Yield minus ECB Refinancing Rate (%) 2
For investors, the implications are straightforward. The euro’s weakening trend has quite a ways to go. Exhibit 4 shows that the euro has already moved from two standard deviations above fair value against the dollar to a much lower level still above fair value. The
In sharp contrast, U.S. consumers’ “cash for clunkers” purchases were on top of the weakest levels since World War II. Unlike the situation in Germany, there is still a deep reservoir of pent-up demand before “normal” levels are reached. Add on the fact that Europe’s traditionally stronger consumer growth markets are hamstrung by impending fiscal austerity, and the ingredients for a European recession are in place as long as the ECB maintains an inverted yield curve. Tighter fiscal policy needs to be complemented with easier monetary policy if a recession is to be averted.
Source: Bbk,ECB/Haver Analytics Source: Deutsche Bundesbank; ECB/Haver Analytics. Data as of 4/30/2010
Data as of April 30, 2010.
\\advjob\agency jobs 2009\G3 Projects 2009\GWIM\CMO\TM CMO Charts 2010-05-17a
capital market outlook 
world was short dollars and long euros going into the recent recession. As it progressed, the Fed ultimately had to provide $600 billion of swap lines to foreign central banks to help ease the dollar shortage that the recession and financial crisis unveiled. As Warren Buffet once said, “when the tide goes out we find out who is swimming without trunks.” Ironically, it turned out to be dollar short positions that need to be covered. The resurrection of the Federal Reserve swap line with the ECB shows that too many investors are still long euros and short dollars.
As seen in Exhibit 4, there have been three basic cycles in the past three decades when the euro got extremely overvalued, as it was in 2008. These cycles don’t stop at fair value when the trend reverses. The euro tends to get undervalued and fall below parity with the dollar. Given the crisis in Europe, it is now easier to see why a move below parity could happen again. In sharp contrast to early 2008, a broad consensus is now doubting the euro. If the U.S. grows about three percentage points faster than Europe in this expansion, as seems likely, U.S. interest rates will eventually rise a good bit above European rates, which are already too high because, like the BOJ, the ECB is way behind the deflation-fighting curve. It has decided to row closer to the deflationary waterfall. If Europe goes the way of Japan, rates could be stuck at low levels indefinitely. In that scenario, the U.S. dollar would attract a lot of capital from Europe, as we are starting to see. That’s very bullish for the greenback. Likewise, healthy emerging economies with their even-higher growth rates will benefit from this capital flow out of Europe.
EXHIBIT 4: Euro Headed to Parity? Exhibit 4 — Euro Headed to Parity? (Synthetic Euro:US$/Euro US$/Euro) (Synthetic Euro: ) 3
Synthetic Euro: US$/Euro z-score
2 +1 st. dev.
0 -1 st. dev.
Sources: Federal Reserve Board/Haver Analytics Data through May 12, 2010
Source: Federal Reserve Board/Haver Analytics. Data through May 12, 2010.
capital market outlook 
Key takeaways3 1. Yes, China is a manufacturing powerhouse — of the 22 categories outlined, China ranked in the top three in all but one category, printing and publishing. The United States ranked in all categories but three — tobacco, wearing apparel and footwear/leather.
Joseph P. Quinlan
World Manufacturing Leaders: A Snapshot One of the greatest untold stories pivots around the manufacturing capabilities of the United States. While investors have been dazed and confused by many market-moving events of late, there are two things they are sure of: The U.S. is not in the business of making “stuff,” and America’s manufacturing capacity has either been allowed to atrophy or shipped to low-cost China.
2. China ranked #1 in ten different sectors — Food and beverages; Tobacco products; Textiles; Wearing Apparel; Leather, leather products and footwear; Chemicals and chemical products; Rubber and plastic products; Non-metallic mineral products; Basic metals; and Electrical machinery and apparatus.
Reality is far different, however. As we have outlined in previous dispatches, the United States is a manufacturing juggernaut, ranked #1 in the world in terms of global share of manufacturing output.2 The fact that manufacturing is playing a key role in the current U.S. cyclical economic upswing is hardly surprising. U.S. consumer demand has revived, capital spending remains robust and U.S. exports to the emerging markets are booming. What better backdrop for a manufacturing giant like the United States?
3. The United States ranked #1 in seven different sectors — Wood products; Paper and paper products; Fabricated metal products; Office, accounting and computing machinery; Radio, television and communication equipment; Medical, precision and optical instruments; and other transport equipment. Note the commanding manufacturing position of the U.S. in high-manufacturing activities like office/ computer machinery, communications equipment and medical/precision equipment.
What about China? Simply stated, the mainland’s manufacturing surge over the past two decades has been stunning; by leveraging low-cost Chinese labor with massive waves of foreign direct investment, China has revamped an economy that could hardly feed itself not that long ago, let alone manufacture anything of value. It is the United States, China and, to a surprising degree, Japan that remain the world’s top manufacturers, as the accompanying table highlights.
4. Japan ranked #1 in five different sectors — Printing and publishing; Coke, refined petroleum products and nuclear fuel; Machinery and equipment; Motor vehicles, trailers and semi-trailers; and Furniture. The nation ranked in the top three in 17 out of the 22 sectors. 5. Europe is poorly represented in the manufacturing rankings — Germany shows up once (Rubber and plastic products), while Italy ranks in the top three in Textiles, Wearing apparel and Leather.
The data in Exhibit 5 come from the United Nations and summarize 22 different categories of global manufacturing, ranging from food and beverages to medical equipment.
6. Notice that in 14 of the 22 sectors, the top three manufacturers are the United States, Japan and China (not necessarily in that order).
lobal investing poses special risks, including foreign taxation, currency fluctuation, risk associated with possible differences in financial standards and other monetary and G political risks. 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.
“International Yearbook of Industrial Statistics 2010,” United Nations Industrial Development Organization. Data for 2008.
Ibid. Data for 2008.
capital market outlook 
country emerges first in the renewable energy space — think solar panels, wind turbines, electric cars, and lithium batteries — will remain or emerge as the global manufacturing powerhouse.
The bottom line The figures are a pointed reminder that contrary to the consensus, the United States is still in the business of making “stuff.” How the rankings look a decade from now remains anyone’s guess. In the near term, China’s manufacturing base is going to have to grapple with rising manufacturing wages and a stronger currency — a challenging backdrop that will test the mainland’s manufacturing nimbleness. The U.S. needs more skilled workers so the shop floors of U.S. factories keep humming; Japan faces intense competition from not only China but also South Korea. And whichever
In terms of investment strategy, it is due in part to America’s manufacturing competitiveness that we maintain a sector overweight in industrials, materials, information technology and energy
EXHIBIT 5: World Manufacturing Leaders (2008, % of Global Total) Food and beverages
Non-metallic mineral products
Paper and paper products
Printing and publishing
Fabricated metal products
Wearing apparel China
Coke, refined petroleum products, nuclear fuel Japan 21.6 China
Machinery and equipment
Motor vehicles, trailers, semi-trailers Japan 24.2 USA
Other transport equipment 13.6
Electrical machinery and apparatus China 27.8 Japan
Source: United Nations Industrial Development Organization. Data for 2008 (latest available data).
capital market outlook 
Medical, precision and optical instruments USA 34.4
Office, accounting and computing machinery USA 59.3
Chemicals and chemical products China 21.1
Rubber and plastic products
Leather, leather products and footwear China 43.2
Radio, television and communication equipment USA 66.5
Furniture; manufacturing n.e.c Japan
we expect certain undervalued emerging-market currencies, especially in Asia and Latin America, to provide the best appreciation potential.
Investment Strategy Committee
•• We remain underweight fixed income. We continue to prefer corporate bonds over Treasuries and international developed bonds.
portfolio strategy and asset allocation •• First-quarter S&P 500 earnings have mostly surprised to the upside, and 2010 and 2011 earnings estimates continue to be revised higher. Top-line growth is accelerating, beating estimates as well. Leading indicators of profits growth predict further vigorous earnings growth. Against this backdrop and assuming no major policy mistakes or external shocks to confidence, equity-market sell-offs, like the Greek credit crisis sell-off, present buying opportunities. We remain overweight U.S. large cap equities.
•• Global rebalancing should create significant opportunities for long/short, distressed debt, and event-driven managers in the hedge fund space. •• We remain cautious on commercial real estate. macro strategy •• The consensus for global growth in 2010 and 2011 is moving up into our 4% to 5% range, with the IMF recently concurring. We have raised our 2010 and 2011 U.S. gross domestic product (GDP) forecast into the 4% to 5% and 3.5% to 4.5% range, respectively, a boost of a half percentage point.
•• We also continue to be overweight small and mid cap equities and emerging markets versus our policy benchmarks but remain selective, preferring countries that are benefiting from the United States and China leading the global economy out of recession (for example, Brazil, Singapore and South Korea). Election-related volatility could provide a better entry point for Brazilian stocks. China’s run-in with Google seems to have hurt its stock market, which has lagged the other BRICs as foreign investors rethink important issues raised by the incident.
•• Among G-7 countries, the U.S. has emerged with the strongest outlook for 2010. Solid recoveries in housing, motor vehicles, capital equipment and software spending are likely. •• There is cumulating evidence that the U.S. labormarket recovery is going to be much more “V-shaped” than the conventional wisdom expects.
•• With regard to sectors, we are maintaining our overweight positions in energy, industrials, materials and information technology. These are the sectors with higher than average exposure to foreign-sourced revenues. Additionally, we remain neutral-weight healthcare and underweight financial and consumer discretionary sectors, where structural headwinds persist.
•• The crisis in the European financial system highlights the fundamental reasons we believe European growth will lag the U.S. Specifically, the euro is overvalued and monetary policy is too tight to allow structural rebalancing. This has created the potential for a “double-dip” recession in Europe, in our view. Hopefully, the directly affected parties will work out a restructuring plan that preempts widespread contagion.
•• We are maintaining our tactical overweight in tangible assets (commodities). We continue to emphasize commodity-linked economies and currencies (Canada and Australia), which tend to outperform the U.S. in an environment of relative commodity price strength that we expect as global reflation efforts succeed. China-tightening concerns should lead to better opportunities in the commodity complex.
•• Given the weakness in the euro’s over-indebted peripheral countries, an overvalued euro is unsustainable and, if it persists, could create a debtdeflation scenario. We think the euro will continue to move back toward, and perhaps overshoot, fair value, which we peg around 1.15. •• In addition to the European debt crisis, our concerns include deleveraging pressures on U.S. small businesses and the impact future policy may have on the segment. We continue to watch the geopolitical landscape closely as tensions in Iran have risen.
•• We think that the dollar will more than hold its own against the euro, the yen, the British pound, and some of the other major currencies. Longer term,
capital market outlook 
Luckily, not everyone is deep in debt and broke. At the other end of the financial spectrum are the developing nations, currently sitting on record amounts of capital. Scared by previous financial crises, the developing nations, led by China, have been more concerned about accumulating reserves — namely, saving — than spending. The upshot is that the so-called poor nations are “rich,” at least relative to the debt-laden developed nations.
Joseph P. Quinlan
Follow the Money: Where the Developing Nations are Spending Excess Reserves As we recently highlighted in a prior dispatch, the world has been turned upside down. The rich are now “poor” and the “poor” are now rich. By this we mean the debt is in the west, the savings in the east — the developing nations.
As Exhibit 7 highlights, the international reserves of the developing nations have soared over the past few years, surging from $1.2 trillion in 1999 to $6.6 trillion a decade later. That equates to more than a fivefold increase. Total reserves of the developing nations rose by nearly 16% last year, with China now sitting atop of some $2.5 trillion. Against this backdrop, a key question for the world financial markets is the following: Where will the developing nations deploy or spend some of their massive riches?
As highlighted by Exhibit 6, the developed nations are now in uncharted water when it comes to aggregate gross debt as a percentage of GDP. Notice that the ratio remained relatively constant from the mid-1990s up until 2007; over this time frame, the ratio averaged just over 73%. Even the figure for 2008, 78%, was not far out of line with the long-term average. However, between 2007 and 2009, aggregate gross debt of the developed nations soared from $27 trillion to $35.1 trillion, a near30% jump in indebtedness necessitated by the financial crisis-cum-global recession of 2008. The combination of more debt and less growth in 2009 yielded a debtto-output ratio of nearly 93%, a level that has spooked investors and raised concerns about sovereign risks, notably in southern Europe.
EXHIBIT 7: ...And the poor Are rich Exhibit 2 — ...and the Poor are Rich (International reserves of the developing nations, Billions of $) (International reserves of the developing nations, Billions of $) 7,000 6,000 5,000 4,000 3,000
EXHIBIT 6: The Rich Are Poor... Exhibit 1 — The Rich are Poor... (Developed Nations Aggregate Gross Debt as % of GDP) (Developed Nations Aggregate Gross Debt as % of GDP)
Source: International Monetary Fund International Financial Statistics, Bloomberg Sources: International Monetary Fund International Financial Statistics; Bloomberg. Data through December 31, 2009 Data through December 31, 2009.
80 75 70
Answer: think energy companies, renewable energy, agricultural commodities, Africa, and infrastructure building at home. Areas which the cash-rich emerging markets are likely to avoid include western banks, given the debt overhang from the public sector and the fact that a number of sovereign wealth funds that bet heavily on U.S. banks during the financial crisis are still nursing large losses from these ill-timed investments.
65 60 55 50 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Sources: Haver Analytics, International Monetary Fund, Bloomberg Sources: Haver Analytics, International Monetary Fund; Bloomberg. Data through December 31, 2009 Data through December 31, 2009.
All sector recommendations must be considered by each individual investor to determine if the sector is suitable for their own portfolio based upon their own goals, time horizon, and risk tolerances. Global investing poses special risks, including foreign taxation, currency fluctuation, risk associated with possible differences in financial standards and other monetary and political risks. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, and the impact of adverse political or financial factors.
capital market outlook 
The emphasis on energy was again reaffirmed this week when Temasek, the Singapore sovereign wealth fund, along with Hopu Investment Management of Beijing, announced plans to ante up some $1 billion for stakes in Chesapeake Energy, a U.S. producer of natural gas. Energy remains a key theme for the developing nations, especially for China and India. Asia’s energy-deficient giants both confront soaring secular demand for energy and power, which has propelled Chinese state-owned energy companies, assisted by the deep pockets of Beijing, to invest heavily in many parts of Africa. As seen in Exhibit 8, Indian and Brazilian companies are also investing heavily, especially in the energy and agricultural infrastructure of Africa, with many deals greased by tax breaks, cheap loans, and other incentives from their respective governments.
In terms of new renewable energy, China is making a huge bet on solar panels and wind power generation equipment. The mainland now accounts for over one-fifth of global investment in renewable energy, and is aggressively pushing ahead with investment in hot water and small hydropower projects, biomass power and solar photovoltaics. In addition, across developing Asia, the Indian subcontinent and the Middle East, billions of dollars from the public sector are being spent on water storage and treatment and pollution control equipment. Infrastructure is another strategic investment target of the surplus developing nations. High-speed railways in China, nuclear power plants in the United Arab Emirates, and hydroelectric dams in Brazil are just a few examples of how the developing nations are deploying their savings. In the aggregate, the developing nations are cautiously and conservatively directing their savings into tangible assets like oil and gas fields, farm land, and copper mines. The challenges presented by finding the energy to power their economies and securing necessary food supplies to feed their populations are the strategic imperatives driving the investment decisions of the capital-rich developing nations.
EXHIBIT 8: Top Acquirers Year-to-Date (Top developing acquirers of developed country targets, 1/1/2010-5/14/2010, Exhibit 3 — Top Acquirers Year-to-Date Billions of $) acquirers of developed country targets, 1/1/2010-5/14/2010, Billions of $) (Top developing Brazil
The upshot is that over the medium term, watch for more joint ventures and merger-and-acquisition (M&A) deals between companies from the developing nations and the developed markets in such sectors as energy, renewable energy, water, and nuclear power. More M&A deals involving technology would not surprise us, either, given the strategic goal of Brazil, India and China to raise their technological capabilities through mergers and acquisitions. In anticipation of these trends, our sector U.S. overweights remain in industrials, energy, materials and information technology. Among our Top Ten Global Themes, we would emphasize water, nuclear, global climate change, and Africa.
Source: Bloomberg Data through May 14, 2010
Source: Bloomberg. Data through May 14, 2009.
capital market outlook 
Economic and Market Forecasts (AS OF april 27, 2010) Q4 2009 e
Q1 2010 e
Q2 2010 e
4.0 – 5.0
4.0 – 5.0
Real U.S. GDP (% q/q annualized)
4.0 – 5.0
4.0 – 5.0
3.5 – 4.5
CPI inflation (% y/y)
0.8 – 1.2
1.5 – 2.5
1.5 – 2.5
Core CPI inflation (% y/y)*
1.3 – 1.6
0 – 1.0
0.5 – 1.5
Real Global GDP (% y/y)
Unemployment rate, period average (%) Fed funds rate, end period (%)
9.0 – 9.8
7.5 – 8.5
0 – 2.0
1.0 – 3.0
10-year Treasury, end period (%)
4.0 – 4.2
3.5 – 4.5
4.0 – 5.0
S&P 500, end period
1200 – 1300
1250 – 1350
1450 – 1550
S&P operating earnings ($/share)
17 – 18
18 – 19
56 – 57 e
78 – 82
88 – 92
$/€, end period
1.28 – 1.38
1.20 – 1.30
1.05 – 1.25
¥/$, end period
90 – 100
95 – 105
100 – 110
Oil ($/barrel), end period
80 – 90
75 – 95
85 – 105
Percent calendar year average over calendar year average annualized unless stated. “e” = Estimate. *Latest 12-month average over previous 12-month average Past performance is no guarantee of future results. Economic or financial forecasts are inherently limited and should not be relied on as an indicator of future investment performance. Source: Investment Strategy Committee. Asset Allocation Table (AS OF april 27, 2010) ASSET CLASS ALLOCATION
High cash positions should consider allocating across all asset classes in a diversified manner (according to the preferences below) over the course of the next 6 months.
We appear to be in the “sweet spot” of global growth, when equities rise and outperform bonds. As a result, we have increased our equity weighting to a stronger overweight.
• We prefer U.S. equities over non-U.S. developed equities. Exceptions are commodity currency countries
(Canada and Australia).
• We remain overweight large cap U.S. equities while maintaining our overweight to small and mid cap U.S. equities versus our policy benchmarks.
• We continue to favor emerging market countries tied to China and the U.S. (for example, South Korea, Taiwan, Singapore, Brazil and Chile).
• We are maintaining our overweight positions in energy, materials, industrials and IT. We are neutral weight healthcare and telecommunications. We are underweight financials, consumer staples, consumer discretionary and utilities.
• We prefer growth over value across all size segments. Fixed Income
We remain underweight fixed income compared to asset classes such as equities that should benefit from diminishing risk aversion.
• We believe an improving economy and healthier corporate balance sheets provide a solid backdrop for corporate bonds
to outperform Treasuries.
• In the municipal space, we would focus on high-quality general obligation and essential-service revenue bonds. Hedge Funds
We are maintaining a neutral weight in hedge funds on a strategic basis.
• We favor long/short strategies and distressed strategies and global macro.
Use a staged approach gaining vintage year and global diversification over time.
• From a sector perspective, we are optimistic on credit strategies, secondary funds, and infrastructure.
Real Estate Funds
Yield investors cautiously build core holdings over the next 6 to 8 quarters.
• We prefer opportunistic and value sectors given adverse market conditions.
Commodities Positioning Emphasis
Commodities and commodity-related investments are starting to benefit from reflation efforts.
• We favor a diversified mix of commodity exposure.
*Tactical qualitative investment strategy weightings are relative in nature versus the full portfolio. Weightings are based on the relative attractiveness of each asset class. Tactical strategy weightings are for a 12-month time horizon. Because economic and market conditions change, recommended allocations may vary in the future. Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. All sector and asset allocation recommendations must be considered in the context of an individual investor’s goals, time horizon and risk tolerance. Not all recommendations will be suitable for all investors. Alternative investments such as derivatives, hedge funds, private equity funds and funds of funds can result in higher return potential, but also higher loss potential. Changes in economic conditions or other circumstances may adversely affect your investments. Before you invest in alternative investments, you should consider your overall financial situation, how much money you have to invest, your need for liquidity and your tolerance for risk.
capital market outlook [ 10 ]
u.s. equity indexes (price return, PERCENT change)
INTERNATIONAL MARKETS (PERCENT change)
S&P 400 MidCap
S&P 600 SmallCap
Russell 1000 Growth
Russell 1000 Value
Russell Midcap Growth
Russell Midcap Value
Russell 2000 Growth
Russell 2000 Value
Dow Jones Indstrl Avg. S&P 500
LAST 12 MONTHS
u.s. equity SECTORS (price return, PERCENT change) 10 ECONOMIC SECTORS OF THE S&P 500 INDEX Cons. Disc.
INDEX WEIGHT 10.46
LAST WEEK 2.67
LAST 12 MONTHS 47.67
BOND INDEXES (BARCLAYS CAPITAL, TOTAL return, PERCENT change) YIELD TO WORST 05/14/10
WEEK % CHANGE
LAST 12 MONTHS.
Corporate and government
EQUITY INDEXES (PRICE RETURN) MSCI EAFE
CLOSE 05/14/10 1,417.82
LAST WEEK 1.91
LAST 12 MONTHS 15.14
S&P/IFCI Emerging CURRENCY Yen per dollar Dollars per euro
u.s. equity INDUSTRIES (price return, PERCENT change) 10 BEST AND WORST PERFORMING GROUPS OF THE S&P 500 INDEX (OF 123)
LAST 12 MONTHS
Construction and Engineering
Wireless Telecom Services
Building Products Gas Utilities
Real Estate Management and Development
Computers and Peripherals
Industry Power Production and Energy Traders
Food and Staples Retailing
Internet and Catalog Retail
Diversified Financial Services
Diversified Consumer Services
u.S. GOVERNMENT BONDS (GENERIC, change IN YIELD From)
Treasury notes and bonds
LAST 12 MONTHS
Global gov’t., ex-U.S.
10-year TIPS (real)
Source: Bloomberg. Indexes are unmanaged, and an investor cannot invest directly in an index.
capital market outlook [ 11 ]
INDEX DEFINITIONS Indexes are unmanaged, and an investor cannot invest directly in an index.
The Barclays Bond Indexes are used as performance benchmarks in each respective category of U.S. debt issuances. The Barclays Capital U.S. Corporate High Yield Bond Index is an unmanaged, market value-weighted index, which covers the U.S. non-investment grade fixed-rate debt market. The index is composed of U.S. dollar-denominated corporate debt in industrial, utility and finance sectors with a minimum $150 million par amount outstanding and a maturity greater than 1 year. The BofA Merrill Lynch US 3-Month Treasury Bill Index consists of a single issue purchased at the beginning of the month and held for a full month. At the end of the month that issue is sold and rolled into a newly selected issue. The issue selected at each month-end rebalancing is the outstanding Treasury Bill that matures closest to, but not beyond, three months from the rebalancing date. To qualify for selection, an issue must have settled on or before the month-end rebalancing date. While the index will often hold the Treasury Bill issued at the most recent 3-month auction, it is also possible for a seasoned 6-month Bill to be selected. The BofA Merrill Lynch 10-15 Year US Treasury Index is a subset of The BofA Merrill Lynch US Treasury Index including all securities with a remaining term to final maturity greater than or equal to 10 years and less than 15 years. The BOVESPA — BOVESPA is a total-return index weighted by traded volume and comprises most liquid stocks traded on the Sao Paulo Stock Exchange. The Chicago Board Options Exchange OEX Volatility Index (VIX) reflects a market estimate of future volatility, based on the weighted average of the implied volatilities of eight OEX calls and puts — the nearest in and out of the money call and put options from the first- and secondmonth expirations. The Conference Board of Leading Economic Index (LEI) — Leading Indexes generally signal activity/output in the coming 3-6 months. Relevant indicators include manufacturers’ new orders, average weekly hours, vendor performance, initial unemployment insurance claims, building permits, money supply (M2), consumer expectations, stock market prices, and interest rate spreads. The Dow Jones Industrial Average Index, the most widely used indicator of the overall condition of the stock market, is a price-weighted average of 30 actively traded blue-chip stocks as selected by the editors of The Wall Street Journal. The Dow Jones U.S. Select Aerospace & Defense Index measures manufacturers, assemblers and distributors of aircraft and aircraft parts primarily used in commercial or private air transport, and producers of components and equipment for the defense industry, including military aircraft, radar equipment and weapons. The index is weighed by float-adjusted market capitalization. The Factset World Aggregate Indexes are time-series composite indexes based on proprietary country, region, sector, and industry classification. Indexes are all based in dollars. The Morgan Stanley Capital International (MSCI) Europe Index is a broad-based index that tracks the performance of European stocks. The Morgan Stanley Capital International (MSCI) Pacific Index is a free float-adjusted market capitalization-weighted index designed to measure equity market performance of developed markets in the Pacific region. The Morgan Stanley Capital International Emerging Markets Index (MSCI EM Index) is a free float-adjusted market-capitalization index that is designed to measure equity market performance in the global emerging markets. As of June 2006, the MSCI Emerging Markets Index consisted of the following 25 emerging market country indexes: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand and Turkey. The Morgan Stanley Capital International Europe, Australasia, Far East (MSCI EAFE) Index is a capitalization-weighted index that tracks the total return of common stocks in 21 developed-market countries within Europe, Australasia and the Far East. The MSCI World Index — The Morgan Stanley Capital International World Index is an index that tracks the performance of global stocks. The Mumbai Sensex — The Mumbai Stock Exchange Sensitive Index is a cap-weighted index. The Nasdaq Composite Index is a market capitalization price-only index that tracks the performance of domestic common stocks traded on the regular Nasdaq market as well as National Market System-traded foreign common stocks and American Depository Receipts. The Philadelphia Federal Reserve Bank Business Outlook Index. The survey panel consists of 150 manufacturing companies in Federal Reserve District III (consisting of southeastern PA, southern NJ and Delaware.) The diffusion indexes represent the percentage of respondents indicating an increase minus the percentage indicating a decrease. The Reuters/Jeffries CRB Index is an arithmetic average of commodity futures prices with monthly rebalancing. The RTSI — The Russian Trading System Index is a capitalization-weighted index that is calculated in U.S. dollars. The Russell 1000 Growth Index measures the performance of those Russell 1000 Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Value Index measures the performance of those Russell 1000 Index companies with lower price-to-book ratios and lower forecasted growth values. The Russell 2000 Growth Index measures the performance of those Russell 2000 Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell 2000 Value Index tracks the performance of those Russell 2000 Index companies with lower price-to-book ratios and lower forecasted growth values. The Russell 3000 Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization, which represents approximately 98% of the investable U.S. equity market. capital market outlook [ 12 ]
The Russell MidCap Growth Index measures the performance of those Russell Midcap companies with higher price-to-book ratios and higher forecasted growth values. The stocks are also members of the Russell 1000 Growth Index. The Russell MidCap Value Index measures the performance of those Russell Midcap companies with lower price-to-book ratios and lower forecasted growth values. The stocks are also members of the Russell 1000 Value Index. The Shanghai Composite — The Shanghai Stock Exchange Composite Index is a capitalization-weighted index. The Standard & Poor’s (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks. The Standard & Poor’s (S&P) 500 Financials Index is a capitalization-weighted index that tracks the Financials sector of the S&P 500, as denoted by the GICS. Other Important Information Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Investing in fixed income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Stocks of small- and mid-cap companies pose special risks, including possible illiquidity and greater price volatility than stocks of larger, more established companies. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, and the impact of adverse political or financial factors. Investments in real 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, such as rental defaults. An investment in a hedge fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage, and short sales which can magnify potential losses or gains. Restrictions exist on the ability to redeem units in a hedge fund. Hedge funds are speculative and involve a high degree of risk.
crisis. Therefore, it is difficult to quantify the benchmark levels of primary issuance and market liquidity that would have been observed following the financial crisis and absent the ensuing reforms. For example, some market participants have noted
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Apr 30, 2010 - month rolling sum of EUR 285bln to EUR 20bn p.a. within the space of a year. ..... has also decided to return to variable rate tenders in ... To put it simply, we again quote Mr Stark: âthe speed ...... America, where domestic demand
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