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2010 Global Outlook
Ten Themes for 2010
January 2010
Larry Adam, CFA, CIMA
Chief Investment Strategist
Telephone (410) 895-4135
Megan Horneman
Investment Strategist
Telephone (410) 895-4148
Ben Sonley
Investment Strategy Analyst
Telephone (410) 895-4282
Jared McDaniel, CFA
Investment Strategist
Telephone (212) 454-6814
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]7/31/2019 2010 Global Outlook Ten Themes+-+DB
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0%
1%
2%
3%
4%
1950 1960 1970 1980 1990 2000
U.S. GDP by Decade Historical Average
0%
1%
2%
3%
1950 1960 1970 1980 1990 2000
U.S. Non-Farm Productivity Historical Average
0%
2%
4%
6%
8%
1950 1960 1970 1980 1990 2000
U.S. Consumer Price Index Historical Average
0%
2%
4%
6%
8%
10%
1970 1980 1990 2000
U.S. New Home Price Historical Average
U.S. GrossDomestic Product
Deciphering the 2000s Decade
Data Source: FactSet, EcoWin, Bloomberg Finance LP. All returns and performance are annualized unless otherwise stated.1 Historical averages include current decade. 2Assuming 4.0% growth in 4Q09. 3 2000 decade through 3Q09. 4 2000 decade through November 2009
1.7%2 3.3%
Since the 1950s, the 2000 decade ranked as
the worst decade, growing at an average annual
rate of 1.7%, half the historical average (3.3%).
Corporate scandals, two wars, a terrorist attack,
the dot com and housing bust led to two
recessions, including the Great Recession.
2.6%3 2.3%
2.6%4 3.8%
2.8%4 5.6%
U.S. Non-FarmProductivity
U.S. ConsumerPrice Index
U.S. Real Estate
2000s Average1
Comments
The dot com bust did have its benefits as the
technological advances made over the 2000
decade led to the highest level of productivity
since the 1960s. Strong productivity helped the U.S. from dipping
into depression in the midst of the recent
recession and helped boost corporate profits.
Inflation has been steadily declining since the
1970s as globalization and robust productivity
have helped reduce pricing pressures. In fact, in
2009 the U.S. experienced its first deflationary
environment since the 1950s.
Inflation in the 2000s was the lowest since the
'60s despite commodities reaching record highs.
Despite the housing boom that temporarily led
to record home prices, the decade saw the
lowest period of home price appreciation.
The decade also included record high
homeownership and subsequently record high
foreclosures and delinquencies.
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-5%
0%
5%
10%
15%
20%
25%
1930 1940 1950 1960 1970 1980 1990 2000
S&P 500 Historical Average
0%
2%
4%
6%
8%
10%
12%
14%
1930 1940 1950 1960 1970 1980 1990 2000
Intermediate Bond Return Historical Average
-4%
-2%
0%
2%
4%
6%
8%
10%
1960 1970 1980 1990 2000
Reuters CRB Commodity Index Historical Average
-4%
-3%
-2%
-1%
0%
1%
2%
1970 1980 1990 2000
Trade Weighted Dollar Index Historical Average
Equity Market
The Decade of Winners and Losers
Data Source: FactSet, EcoWin, Bloomberg Finance LP. All returns are annualized unless otherwise stated.1 Historical averages include current decade. 2 4Q09 earnings estimate from FirstCall. 3 Ibottson Intermediate Government Bond Index and Barclays Aggregate Govt (5-10Y).
-0.9% 9.5%
Despite touching a record high for the sixth
consecutive decade, the S&P 500 experienced
its steepest drop since the Great Depression,
erasing all its gains and finished its worst
decade on record.
In addition, earnings grew (1.9%) at the slowest
pace on record.2
6.0% 5.5%
6.3% 2.7%
-2.7% -1.1%
Bond Market3
Commodities
Dollar
2000s Average1
Comments
Bond yields continued their downward descent
through the 2000 decade, falling for the third
consecutive decade.
Although they did not post the best decade on
record, they did post an above average return.
In addition, ten year Treasury yields reached a
record low and T-bills dipped negative for the
first time on record.
The global economy expanded in the 2000
decade led by robust growth in the emerging
markets. As a result of the increase in
incremental demand, many commodities
reached a record high during the decade.
While it was not the best decade on record, the
2000 decade saw above average performance
for commodities.
The dollar declined during the decade due to
rising fiscal and trade deficits, subpar economic
growth, a reduction in the growth of capital
flows, and falling interest rates.
However, the dollar continued to be a viewed as
a safe haven currency as it appreciated during
the times of crisis that included the bursting of
the tech and real estate bubbles.
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Honeymoon Rebound Masks Fundamental Weakness
Which Gray Block is Darker?
1
Data Source: Wikipedia Contrast Effect
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U.S. GDP Forecasts
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10
Honeymoon Rebound Masks Fundamental Weakness
What Will Drive Growth? At Least in 2010
Data Source: Bloomberg Finance LP.
*Deutsche Bank Global Markets 2010 GDP forecasts
Although the economic recovery is expected to be fairly muted, byhistorical standards, growth is expected to grow by more than 3.0% in
each quarter through 2010.
U.S. GDP Expected to Rebound through 2010*
1
Government Spending
Infrastructure
spending peaks in 1H10
Weak Dollar: Net Exports
Competitiveness of U.S. goods has increased
Capital Investment
Capex spending over hiring people in a joblessrecovery
Stealth Stimulus
The wild card in an election year
Inventory Restocking
Inventories remain at historically low levels
The Baby V
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Honeymoon Rebound Masks Fundamental Weakness
'86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
3%
4%
5%
6%
7%
8%
9%
10%
11%Correlation: -0.76
NFIB Small Business Hiring Plans, Percent - United States (Lef t)
Unemployment Rate, Percent - United States (Right)
Jobless Recovery Underway
Data Source: FactSet, EcoWin.
*Cartoonist Group, Gary Varvel Editorial Cartoon
Small business hiring makes up 65-70% of the total labor market.
Recent small business surveys show that there is little improvementin the outlook for hiring.
In addition, regional surveys show corporations favoring capital
expenditures over hiring of new employees.
Government Uncertainty Weighing on Hiring Plans*
1
Uncertainty surrounding changes to government policy and the future
outlook for the economy have led to hesitation among businesses toexpand their labor force.
This will likely result in a jobless recovery unfolding which we define
as the unemployment rate falling to 9% (from 10% currently) by the
end of 2010, but having difficulties falling further.
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-35
-30
-25
-20
-15
-10
-5
0
5
1932 1939 1946 1953 1960 1967 1974 1981 1988 1995 2002 2009
in%
terms
Deficit as % GDP (LHS)
Honeymoon Rebound Masks Fundamental Weakness
Government Deficit to Weigh on Growth
Data Source: FactSet, EcoWin.
*Cartoonist Group, Lisa Benson Editorial Cartoon
Government Becoming a Burden*
1
Government spending has worked to mitigate the negative effects of the Great Recession. However, the price tag has been expensive and thedeficit as a percentage of GDP has reached the highest levels seen since the 1940s.
In addition, based on the projections given in the 2010 U.S. Governments fiscal budget, the deficit as a percentage of GDP is expected to be
above the historical average (-3.1%) through at least 2012.
Real GDPAveraged
4.0%
Real GDPAveraged
4.4%
Real GDPAveraged
9.1%
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$0
$500
$1,000
$1,500
$2,000
$2,500
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
inbillions
Total Spending on Medicare, Medicaid and Social Security
Net Interest Costs
Honeymoon Rebound Masks Fundamental Weakness
0
1
2
3
4
5
6
7
8
9
10
1930 1940 1950 1960 1970 1980 1990 2000 2010 2015 2020 2025 2030
#ofpeople
Ratio of 25-64 Year-Olds to 65 and Older
Spending on Aging Population
Data Source: U.S. Census Bureau,
*Future projections according to the Office of Management and Budget 2010 U.S. Government Budget (Table S-3).
When social security was developed (signed into law in 1935) there
were approximately 8.6 Americans working to support each retiree. However, given the aging demographics of our country, that number
has been cut in half to four people working for every one retiree.
By current census estimates, that number is expected to fall to 2.5 by
2030.
Aging Population Threatens Long-Term Growth
1
The spending on just the aging population has continued to climb,
and given current budget projections, spending on medicare/medicaidand social security alone will exceed $2.0 trillion by 2013, or 12% of
projected GDP.
est
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Honeymoon Rebound Masks Fundamental Weakness
The Economic Recovery is Vulnerable
Data Source: *Cartoonist, Karl Wimer Editorial Cartoon
Given our outlook for rising interest rates in 2010, the housingrecovery may face challenges.
Mortgage rates have averaged 5.0% in 2009. However, without the
Fed supporting the mortgage rate by buying mortgage backed
securities and the overall rise in interest rates, mortgage rates may
creep higher.
Rising Interest Rates to Impact Housing Recovery*
1
Higher Interest Rates
The 10-Year Treasury Bond yield approaching
5% would be problematic
Weak Confidence
Languid confidence = hesitant spending
Rising Energy Prices
Gasoline above $3/gallon would be a burden
Protectionism
Trade wars could hamper the benefits of
globalization
Tight Credit
Stringent bank lending = limited growth
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0
10
20
30
40
50
60
70
Dec-60 Dec-70 Dec-80 Dec-90 Dec-00 Dec-10
in%t
erms
Debt Held by the Public (Marketable Debt Only) as Percentage of Real GDP '02 '03 '04 '05 '06 '07 '08 '09-20%
0%
20%
40%
60%
80%
100%
120%
(% 1YR) Treasury Securities, Held by Public, Bills - U.S.(% 1YR)Treasury Securities, Held by Public, Notes - U.S.
The Crowd Pushes Interest Rates Higher
Treasury Extends Debt Maturity
In addition, the Treasury has stated that they plan to extend the
average maturity of their debt from 4.6 years to 6 or more years.
After using the bill market as a way to fund the debt problem in
2008-2009, the Treasury has begun the process of shifting their debt
maturities longer and on a year-over-year basis the amount of bills
outstanding is negative.
Data Source: FactSet, EcoWin.
*Future projections for debt held by the publica are estimates from Congressional Budget Office.
The Treasury debt is expected to rise to a record high as a
percentage of GDP in 2010 at over 60% of GDP. As a result, the surge in issuance is likely to put upward pressure on
yields.
Swelling Debt Problem*
2
Est
TheDebtSwap
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-$50
-$40
-$30
-$20-$10
$0
$10
$20
$30
$40
$50
$60
Dec-84 Dec-89 Dec-94 Dec-99 Dec-04 Dec-09
$billions
0%
2%
4%
6%
8%
10%
12%
14%
Net New Cash Flow into Bond Mutual Funds (LHS )
10-Year U.S. Treasury Yield (RHS)
The Crowd Pushes Interest Rates Higher
'70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08
0%
5%
10%
15%
20%
Yield On U.S. Treasury Bonds, 10-Year - United States(% 1YR) CPI All items - United StatesRecession Periods - United States
Fund Flows to Reverse as Risk Appetite Increases*
The amount of new money placed into bond funds has been robust
this year while there has been net outflows of equity funds. As risk appetite increases and economic fundamentals continue to
improve it is likely that investors will move funds out of bond funds in
search for higher yielding assets with better return potential.
Data Source: FactSet, EcoWin, Investment Company Institute.
*Year-to-date through December 22, 2009 and 10-year U.S. Treasury yield as of December 31, 2009.
Yields have been on a steady decline since the early 1980s as
inflation has steadily declined. Over the past year, yields have been pushed to historically low levels
as a result of the first period of deflation since the 1950s.
However, as inflationary pressures increase, yields at current levels
are unlikely sustainable.
Return of Inflation Threatens Low Yields
2
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0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
U.S. Treasury 2-
Year
Barclays U.S.
Agg Credit (1-5Y)
Barclays U.S.
Agg High Yield
Barclays U.S.
Agg Credit (7-
10Y)
U.S. Treasury 10-
year
in%terms
Duration Coupon
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The Crowd Pushes Interest Rates Higher
-200
0
200
400
600
800
1,000
1,200
Barclays U.S. MBS Barclays Govt-
Agency
Barclays Credit Barclays High Yield
inbps
Spread Level at end of 2008 versus Historical Average
Current Spread Level Minus Historical Average*
Favor Products with Positive Carry**
Most of the easy money has already been made and corporate
bonds are unlikely to produce similar record returns as seen in
2009.
As a result, investors will need to look opportunistically for credit at
both the sector and individual bond levels.
Data Source: FactSet, EcoWin.
*As of December 31, 2009
**Returns are for illustrative purposes only.
Given our expectation for an overall rise in interest rates in 2010,
investors should focus on products that have a lower duration which
may help mitigate the interest rate risk.
Corporate bonds tend to offer a better coupon return to cushion the
losses of principal in a rising rate environment and should benefit
from an improving economy.
Easy Money Has Been Made from Credit Market
2
Once in ageneration
opportunities haveevaporated
-5.00%-1.00% 2.50% 4.10% -0.40%
Total Return Assuming a 1% Increase in Interest Rates
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Taxing the U.S. Consumer
02
4
6
8
10
12
14
16
18
Cigarettes/Tobacco
TaxIncrease
OtherTaxes*
SalesTaxIncrease
PersonalIncome
TaxIncrease
CorporateTax
Increase
AlcoholTax
Increase
MotorFuelsTax
Increase
# of States
Consumer Taxes Rising*
In order to combat the swelling budget deficits at the state level,
states have resorted to taxing items such as cigarettes, alcohol and
motor fuel.
In addition, 12 states have enacted sales tax and personal income
tax increases.
By the extra taxation, the 50 states are expected to raise $24 billion
in fiscal year 2010. It would be the largest amount of revenue raised
on record (records began 1979).
Data Source: FactSet, EcoWin.
*The Fiscal Survey of States, December 2009, National Association of State Budget Officers.
Some municipals offer investors an attractive yield in relation to
Treasuries and may benefit from increased retail demand as
investors position portfolios in anticipation of higher taxes.
In addition, in 2010 issuers may opt to issue debt as a part of the
Build America Bond program instead of the traditional tax free debt
because it offers an advantage to the issuer.
This may create a supply/demand imbalance that benefits municipals.
Municipals Attractive Relative to Treasuries
3
50
100
150
200
Dec-87 Sep-90 Jun-93 Mar-96 Dec-98 Sep-01 Jun-04 Mar-07 Dec-09
in%terms
Barclays Municipal 10-Year (GO) as % of 10-Year U.S. Treasury
Historical Average Municipal as % of Treasury Ratio
Municipal as a % of Treasury ratios remain
above average.
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Consumer Pain Grows
Taxing the U.S. Consumer
'60 '63 '66 '69 '72 '75 '78 '81 '84 '87 '90 '93 '96 '99 '02 '05 '080
10,000
20,000
30,000
40,000
50,000
60,000
70,000
-5%
0%
5%
10%
15%
Households & Nonprofit Organizations Net worth (Left)(% 1YR) Personal Income (Wages and Salary Disbursements) (Right)
Market Overly Optimistic on Consumer
Valuations for consumer staples are more attractive than consumer
discretionary. While earnings growth is expected to be higher indiscretionary stocks, the current estimates may be unrealistic given
the projected consumer weakness.
In addition, given our expectation for the dollar to remain at relatively
low levels we favor sectors with a large exposure to foreign sales
(staples over discretionary).
Data Source: FactSet, EcoWin, IBES Aggregates
3
%f
romi
ts15-
yearaverage
Absolutelevel
Consumers have already felt the pain through wages that have fallen
at a record pace. In addition, net worth remains $12 trillion below itsrecord high.
Consumer discretionary stocks have significantly outperformed the
staples sector in 2009 (41.3% versus 14.9%) as economic
fundamentals have improved. However, given the ongoing challenges
that the consumer will face in 2010, the recent rally is unlikely
sustainable. Therefore, we favor consumer staple stocks over
consumer discretionary stocks.
Valuation Mea suresConsumer
Discretionary
Consumer
Staples
Price to Earnings -11.6% -22.9%
Price to Book Value -8.9% -55.6%
Price to Cash Flow 115.5% -14.1%
Dividend Yield 1.3% 2.9%
Operating Margin 4.4% 9.9%
Earnings Growth (NTM) 29.3% 8.5%
Foreign Sales as % of Total
Sales28.0% 44.0%
in$billions
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0
750
1,500
2,250
3,000
3,750
Dec-39 Dec-55 Dec-71 Dec-87 Dec-03 Dec-19
Data Source: Bloomberg Finance LP, Deutsche Bank U.S. PWM Investment Strategy Group
S&P 500 path using historical average rallyfrom each decade high = 136%
1675
1940s-25.7%
1950s215%
1960s79%
1970s11%
1980s199%
1990s308%
2000s7%
The S&P 500 has hit a record high inevery decade beginning in the1950s.
On average, each decade rally to its
next record high (in the proceeding
decade) has been 136%.
However, the rally in the 2000s to the
most recent record high reached in
October 2007 was only 7% (the lowest
subsequent record high) from the
record high hit in the 1990s.
S&P 500 path assumingS&P 500 rallies 7% in the2010 decade, similarly tothe 2000 decade = 7%
3700
Global EquitiesThe Hard Work Begins4
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-100%
-50%
0%
50%
100%
150%
200%
1/25/29 3/9/39 4/20/49 6/2/59 7/14/69 8/26/79 10/7/89 11/19/99 12/31/09
Rolling 1-Year Price Return of S&P 500
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
P/E Contraction/Expansion
Global EquitiesThe Hard Work Begins
P/E Contraction Ahead?
The P/E expansion seen during 2009 has matched the historical P/E
expansion in the year the recession ends (+26%). Historically, going back to 1960, on average, P/Es expand 27% in
the year before the recession ends.
However, going back to 1960, on average, P/Es contract by 11.6%
in the year after the recession ends.
Data Source: FactSet, EcoWin
The S&P 500 has seen a significant rebound after the record decline
it experienced in the beginning of 2009. In fact, the rebound has been the most substantial since 1998. Going
back to 1929 there have only been five rebounds of greater
magnitude than the 2009 rebound.
Historical Rebound Absorbed
4
Largest 1-year rally since 1998
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-5%
0%
5%
10%
15%
20%
25%
-12 -9 -6 -3 -1 +1 +3 +6 +9 +12
# Months
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
S&P 500 Performance (LHS) % of Time Positive (RHS)
0%
2%
4%
6%
8%
10%
12%
14%
16%
3 months 6 months 12 months
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Average S&P Performance (LHS) % of Time Positive (RHS)
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Global EquitiesThe Hard Work Begins
S&P 500 Performance Surrounding Rate Hikes**
Historically, the S&P 500 experiences robust returns in the year
leading up to the Fed raising rates, while after they raise ratesreturns moderate.
Given our expectation that the Fed will remain on hold until 2H10 at
the earliest, the current environment is favorable for equities.
In the 3, 6, and 12 months after the unemployment rate peaks, equity
returns are typically favorable.*
Unemployment Peaking?*
4
Data Source: FactSet, EcoWin.
*Observations include returns surrounding the 1969-1970, 1973-1975, 1981-1982, 1990, 2001 recessions. **Time period surrounds the rate hikes after the recessionof 1973-1975, 1980, 1981-1982, 1990-1991, 2001.
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0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
S&P 500 Performance One Year Before
Earnings Growth is M ore Than 20%
S&P 500 Performance in Year that Earnings
Growth is More than 20%
82%
84%
86%
88%
90%
92%
94%
96%
98%
100%
hhhuu Percentage of Time Positive (RHS)
0%
5%
10%
15%
20%
25%
1-Year 2-Year 3-Year 4-Year 4-Year Average
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Average Earnings Growth in Year After Earnings Bottom in Recession (LHS)
% of Time Positive (RHS)
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Global EquitiesThe Hard Work Begins
S&P 500 Returns Surrounding 20% Earnings Growth
Historically, the average return during the year 20% earnings growth
is achieved (13 times since 1936), is less robust than the year prior(16.8% versus 10%).
Historically, earnings tend to recover at an above-average pace as
the economy rebounds from a recession. Our earnings estimate for 2010 is $76 which would represent a 25%
earnings growth from 2009.
Earnings Stabilizing and Rebounding?*
4
Data Source: FactSet, EcoWin.
*Time period reflects 1938-2001.
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'01 '02 '03 '04 '05 '06 '07 '08 '090.4
0.5
0.6
0.7
0.8
0.9
1.0
1.1
1.2
Relative Attractiveness of MSCI Asia Ex Japan P/E (NTM) versus S&P 500 P/E (NTM)Trendline: Linear with 1st standard deviation, trend based
'90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '090.7
0.8
0.9
1.0
1.1
1.2
1.3
1.4
Relative Attractiveness of MSCI Europe ex UK P/E (NTM) versus S&P 500 P/E (NTM)Trendline: Linear w ith 1st standard deviation, trend based
Asian Multiples to Expand with Economic Maturation
Data Source: Bloomberg Finance LP, FactSet, EcoWin.
Europe Becoming More Expensive Versus U.S.
4
Europe expensive versus U.S.
Europe attractive versus U.S.
When looking at the forward P/E for the MSCI Europe ex UK relative to
the S&P 500 on a trend basis, Europe has become increasinglyexpensive.
Global EquitiesThe Hard Work Begins
As Asian economies mature and become more stable, multiples will
likely expand and the gap between Asian and developed marketmultiples is likely to shrink.
Asia has upside potential as they may receive the benefit of a re-
rating (i.e. P/E expansion).
Asia expensive versus U.S.
Asia attractive versus U.S.
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100
110
120
130
140
150
160
170
180
0 11 22 33 44 55 66 77 88 99 110 121 132 143 154 165 176 187 198 209 220 231 242 253
# of days
1949 1957 1970 1974 1982 1990 2002 2009
The Most Powerful Post World War II Equity Rally*
Phase I:Reflex RallyStabilization of BankingSystem
Armageddon ScenarioDissipates
Phase 2:P/E ExpansionAnticipation ofEarnings Recovery
Cost Cutting BoostsProfits
Phase 3:Confirmation of Economic andEarnings Recovery
Sustainable Growth ProspectsTop Line Revenue Growth
5 Proliferation of Pullbacks
Source: FactSet.
*As of December 31, 2009
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-30%
-25%
-20%
-15%
-10%
-5%
0%
1946 1954 1958 1961 1971 1975 1980 1983 1994 2004
Largest Pullback in 12 Months Surrounding First Fed Rate Hike
Average: -11.0%
-45%
-40%
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
1930 1938 1946 1954 1962 1970 1978 1986 1994 2002
Largest Pullback in12 Months Surrounding Mid-Term Elections
Average: -17.6%
Proliferation of Pullbacks
Mid-Term Elections Could Lead to Pullbacks
In addition, uncertainty surrounding the mid-term elections has alsobeen a catalyst for declining equity prices.
In the 12 months surrounding the mid-term elections, which will take
place in November, the S&P 500 has incurred a temporary decline,
on average, of 17.6%.
Data Source: FactSet, EcoWin, Bloomberg Financial L.P.
*Fed Funds Target Rate 12/1970 Present, Effective Fed Funds Rate 7/1954 12/1970, Discount Rate 1934-7/1954
Fed Rate Hikes or*
The expectation and realization of a Fed rate hike has historically led toa pullback in equity markets.
On average, the S&P 500 experiences an 11% decline in the 12 months
surrounding (six months before and six months after) the first interest
rate increase.
5
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-25.0%
-20.0%
-15.0%
-10.0%
-5.0%
0.0%
1973 1978 1980 1984 1994 2006
Largest Pullback in 12 Months Surrounding 200bp Rise in 10 Year Treasury Yield
Average: -13.2%
Proliferation of Pullbacks
Rising Bond Yield Ramifications?
Data Source: FactSet, EcoWin
Rising Bond Yields Could Interrupt Equity Rally
Our expectation for 10-year Treasury yields to rise to 4.50% in 2010would place yields 244 bps above their low made in December 2008.
Historically, a rise in yields in a similar magnitude has coincided with
declines in equity prices. On average, in the 12 months surrounding a
200 bps rise in bond yields, equity prices have experienced a temporary
pullback of 13.2%.
5
Despite the decline in household and business debt, the U.S.economy continues to be largely dependent on debt.
This could pose challenges to consumers, business and the
government as rates rise throughout 2010.
On average, the S&P 500 has suffered a 34% pullback during these
time periods. These include the crash of 1987 (-32%), the midcycle
slowdown (-8%), the tech collapge (-37%) and the Great Recession
(-57%).
0%
50%
100%
150%
200%
250%
300%
3Q54 3Q59 3Q64 3Q69 3Q74 3Q79 3Q84 3Q89 3Q94 3Q99 3Q04 3Q09
0
2
4
6
8
10
12
14
16
in%t
erms
Total Debt (Public, Household and Business) as % of Real GDP (LHS)*
10-Year U.S. Treasury Yield (RHS)
GreatRecession
TechCollapse
Crashof 1987
Mid cycle
slowdown
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'00 '01 '02 '03 '04 '05 '06 '07 '08 '09-20
0
20
40
60
80
100
0
10
20
30
40
50
60
70
CBOE Volatil ity Index (VIX), Percent (Right)CSFB/Tremont HF Long/Short Equity (Index) - S&P 500 (Index) (Left)
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
W hen VIX Rises for the Year W hen VIX Falls for the Year
HFRI Fund of Funds Index Performance Relative to S &P 500
HFRI Equity Market Neutral Index Performance Relative to S& P 500
Proliferation of Pullbacks
Increased Volatility Benefits Hedge Funds*
Two strategies which have tended to benefit from increased volatilityhave been fund of funds and equity market neutral. Since 1991
these two strategies have outperformed the equity market in years
when the VIX rises while they have, on average, underperformed in
years when the VIX falls.
Data Source: FactSet, EcoWin.
*Time period reflects December 31, 1990 to November 30, 2009.
Hedge Fund Strategy Flexibility Should Benefit
Historically hedge funds have benefited from increased volatility as theyprovide investors with upside exposure while protecting against
downside risks.
5
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-4%
-2%
0%
2%
4%
6%
8%
10%
12%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Average Large Cap Equity M utual Fund Outperformance vs. S &P 500 (LHS)*
% Outperforming (RHS)
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
Lehman
Aggregate
Benchmark
Russell 2000
Benchmark
S&P 500
Benchmark
MSCI EAFE
Benchmark
MSCI EM
Benchmark
2009 Mutual Fund Outperformance vs. Benchmark
Average Mutual Fund Outperformance vs. Benchmark
Alpha Mojo to Continue; Albeit at a Slower Pace
Large Cap Mutual Funds Best Performance Since 2000
In addition to the strong outperformance from fixed income and
small-cap equity mutual funds, large-cap equity mutual funds postedtheir best performance since 2000. Further, 67% of the largest 100
funds outperformed the S&P 500, the largest ratio since 2005.
While we expect active money managers to continue to outperform,
the magnitude of outperformance will be to a lesser extent.
Data Source: FactSet, EcoWin.
*As of December 31, 2009.
2009 Portfolio Manager Performance Was Strong*
Fixed income mutual fund managers posted their best outperformance
relative to the Lehman Aggregate Index benchmark (more than 1,000bps) since at least 2000. Small cap mutual fund managers also
benefited from the broad-based risky asset rally, posting their best
relative performance since 2001.
6
SignificantAlpha
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-5%
15%
35%
55%
75%
95%
115%
135%
Barclays
Credit
(AAA)
Barclays
Credit (AA)
Barclays
Credit (A)
Barclays
Credit
(BAA)
Barclays
High Yield
(B)
Barclays
High Yield
(BA)
Barclays
High Yield
(CAA)
Barclays
High Yield
(CA to D)
20 09 Tota l R etur n B arc la ys U.S. Aggr egate Cr edit
15.5%
38%
72.7%
0%
10%
20%
30%
40%
50%
60%
70%
80%
0-0.75 0.76-1.25 1.26-2.0
2009 Price Return S&P 500
Alpha Mojo to Continue; Albeit at a Slower Pace
...and Low Quality Bonds
Data Source: FactSet, EcoWin.
The Rally Benefited High Beta Equities...
As the Armageddon scenario was priced out of the market, high beta
and low quality stocks led the nearly uninterrupted rally. However, in2010 investors will need to be more selective at both the stock and
sector level as returns of this magnitude are unlikely.
6
This phenomenon was also seen in the fixed income market with the
lowest quality corporate bonds significantly outperforming the highestrated bonds.
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0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Telecom
Utilities
Consumer Staples
Healthcare
Industrials
Info Tech
Consumer Discretionary
Energy
Materials
Financials
2010 Consensus Earnings Growth Estimates*
Alpha Mojo to Continue; Albeit at a Slower Pace
0
10
20
30
40
50
60
InfoTech
Energy
Materials
Consumer
Staples
Healthcare
Industrials
Consumer
Discretionary
Financials
Utilities
Telecom
in%t
erms
Foreign Sales as a % of Total Sales
2010 Earnings Growth By Sector
Earnings growth versus expectations will be a critical driver of
equities in 2010.
Global cyclical sectors such as energy and technology should
deliver above average earnings growth.
Data Source: FactSet, EcoWin.
*Earnings estimates as of December 2009.
Foreign Sales Paramount to Revenue Growth
Currently, U.S. corporations get approximately 40% of their profits from
overseas.
Given our outlook for a relatively weak dollar, investors should focus on
sectors with high exposure to foreign sales.
6
ISG 2010 Earnings Growth Estimate
More optimistic
earnings
expectation thanconsensus
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Yearning for Yield
A Return of Dividends?
After dividends were cut at a record pace in 2008 and 2009, it is
likely companies will begin to increase dividends in 2010 aseconomic conditions improve.
We estimate that dividends paid by the constituents of the S&P 500
will increase by at least 2% in 2010.
The Importance of Dividends*
7
Data Source: FactSet, EcoWin.
*Cartoonstock.com, John Morris.
**As of December 2009.
'62 '65 '68 '71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07-30%
-20%
-10%
0%
10%
20%
30%
(% 1YR) S&P 500 - Dividends Per Share
Dividends have become an increasingly important part of equity
returns. In fact, since January 1928 the total return of the S&P 500 has
nearly doubled (+9.5%) the price return of the S&P 500 (+5.2%).**
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0.20
0.25
0.30
0.35
0.40
0.45
0.50
0.55
0.60
0.65
0.70
1962
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
Dividend Payou t Rat io H is tori cal Ave rage
Yearning for Yield
'47 '50 '53 '56 '59 '62 '65 '68 '71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
Corporate Net Cash Flow (annual rate, bill ion. chain 2000 $)
Cash Flow Supportive of Dividend Hikes
However, with corporate cash near record highs and economic
fundamentals improving, companies may be more inclined to raisedividends in 2010.
After being cut at a rapid pace the dividend payout ratio remains near
record lows.
Dividend Payout Ratio to Expand?
7
Data Source: FactSet, EcoWin.
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-1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
10/28/99 7/6/01 3/15/03 11/21/04 7/31/06 4/8/08 12/16/09
in%t
erms
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
in%t
erms
Difference between Bond and Dividend Yield (RHS)
Barclays U.S. Credit (1-5YR) After Tax Yield (LHS)
S&P 100 After Tax Yield Dividend Yield (LHS)
0
5
10
15
20
25
Consumer
Staples
Industrials
Utilities
Financials
Consumer
Discretionary
Energy
Energy
Materials
Healthcare
Telecom
InfoTech
#ofcompanies
Number of Companies with Dividend Yield in Excess of Intermediate Corporate Bond Yield
Yearning for Yield
Dividend Yielding Sectors
Currently, there are 101 companies within the S&P 500 that have
dividend yields in excess of their intermediate corporate bond yields.Consumer staples, industrials and utilities have the most amount of
companies that meet this criteria.*
For yield seeking investors, equities have become an increasingly
attractive alternative versus corporate bonds.
Dividends Attractive Versus Bond Yields (After Taxes)
7
Data Source: FactSet, EcoWin.
*As of December 31, 2009.
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Follow the Money
-$30,000
-$25,000
-$20,000
-$15,000-$10,000
-$5,000
$0
$5,000
$10,000
$15,000
$20,000
$25,000
Jan-
09
Feb-
09
Mar-
09
Apr-
09
May-
09
Jun-
09
Jul-
09
Aug-
09
Sep-
09
Oct-
09
Nov-
09
Dec-
09
in$millions
Total Equity Flows (Domestic and International)*
Flows Follow Performance
Bonds have largely benefited from a strong inflow of money but
returns have turned negative for Treasury bonds.
As conditions improve it is likely that investors will follow the positive
performance and increase equity exposure.
Domestic equity flows have been largely negative in 2009. However,
in 2010 as economic fundamentals improve and risk appetiteincreases we expect to see this reverse and investors shy away from
the safety of bonds in favor of higher yielding assets (e.g. equities).
Fund Flows to Return to Equities in 2010?
8
Data Source: FactSet, EcoWin, Investment Company Institute.
*December fund flows as of December 22, 2009.
1/07 4/07 7/07 10/07 1/08 4/08 7/08 10/08 1/09 4/09 7/09 10/09 1/10-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
Barclays Capital U.S. Aggregate Govt - Treasury - Trail ing 1-Year Return(% 1YR) S&P 500 - Trailing 1-Year Return
Positive Equity Performance!
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Total Debt as Percent of Equity
0
50100
150
200
250
300
350
400
InfoTech
Energy
HealthCare
Consumer
Staples
Materials
Consumer
Discretionary
Telecom
Utilities
S&P500
Industrials
Financials
in%t
erms
-75%
25%
125%
225%
325%
425%
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Yearly Change in M&A Activity
Follow the Money
M&A Activity Expected to Increase in 2010*
M&A activity should pick up in 2010 as cash rich companies take
advantage of attractive opportunities.
We would favor sectors that have healthier balance sheets and are
cash rich (e.g. tech, energy and healthcare) over those sectors that
are more highly leveraged.
Favor Cash Rich Sectors
8
Data Source: FactSet, EcoWin.
*As of December 31, 2009. Mergerstat. U.S. companies only. Deals that are pending or completed for all acquisition types.
Healthier Balance Sheets
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0 50 100 150 200 250
Mexico
Germany
Netherlands
Australia
Brazil
China
Sweden
United States
Japan
Portugal
Italy
Abu Dhabi
Spain
Greece
Venezuela
Change (in bps) of Current CDS versus 52-Week Low
Follow the Money
'97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09-50
0
50
100
150
200
250
0
100,000
200,000
300,000
400,000
500,000
600,000
700,000
800,000
900,000
Merrill Mortgages - Master - Option Adjusted Spread (OAS) (Lef t)Federal Reserve Banks Asse ts, Mortgage-bac ked Securities (Mil $) - U.S. (Right)
Are Credit Default Spreads Signaling Risks?*Fed Purchase Programs Expiring?
8
Data Source: FactSet, EcoWin, Bloomberg Finance LP.
*As of January 4, 2010.
**When a CDS rate is rising, it is an indicator of worsening credit quality. When it is falling it is an indicator of better credit quality.
While the economic recovery is expected to continue into 2010,
some sectors of the economy have further problems to face. TheFederal Reserves purchases of mortgage-backed securities (MBS)
have effectively narrowed, however, as those purchases are phased
out, we believe MBS will underperform other sectors of the credit
market.
Credit default swaps are a good indicator of the credit quality of a
specific country.**
Since their 52-week low, countries that have been reliant on
leverage have seen the largest widening in their credit default swap
rates.
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-80
-70
-60
-50
-40
-30
-20
-10
0
Oct-92
Oct-93
Oct-94
Oct-95
Oct-96
Oct-97
Oct-98
Oct-99
Oct-00
Oct-01
Oct-02
Oct-03
Oct-04
Oct-05
Oct-06
Oct-07
Oct-08
Oct-09
$billions
0
20
40
60
80
100
120
140
U.S. Trade Deficit /Surplus (LHS) Trade Weighted Dollar Index (RHS)
Diverging Dollar
Can the Trade Deficit Help Stabilize the Dollar?
Generally, a wide trade deficit negatively impacts a countrys
currency. However, if the deficit is wide due to higher exports than
imports this could help boost domestic growth which may boost the
value of a currency.
Given the relative weakness of the dollar, U.S. goods are attractive
overseas and exports are expected to rise through 2010.
We expect the dollar will face challenges in 1H10 as wide interest
rate differentials, a burgeoning budget deficit and increased risk
appetite weigh on the dollar.
Dollar to be Challenged in 1H10*
9
Data Source: FactSet, EcoWin.
*Cartoonstock.com, Ed Fischer.
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0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
China India Brazil Russia United
States
Euro Area Japan
China India Braz il Rus sia Unit ed S tat es E uro Area Japan2010 Year-End Projected Interest Rate Moves
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
Japan ECB U.S. BOE China Canada Brazil India
Diverging Dollar
Interest Rates to Be Highest in Emerging Markets
In addition, interest rate differentials are expected to remain wide
between the U.S. and the emerging market economies as strong
economic growth and inflation fears result in those central banks
removing liquidity at a faster and more dramatic pace.
The dollar is likely to lead the developed market economies in growth
next year which should help the dollar stabilize (versus euro) and
even strengthen (versus yen). However, growth is l ikely to lag the
emerging market economies and as a result the dollar should
continue to weaken against these countries.
Growth Favors Dollar over Other Developed Currencies
9
Data Source: FactSet, EcoWin, Deutsche Bank Global Markets estimates.
Better Growth ProspectsDrive Capital Flows
Better Short Term Investment Rates
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0
10
20
30
40
50
60
70
80
90
100
Capacity Utilization -
Primary Metals
Capacity Utilization - Food,
Beverage and Tobacco
Capacity Utilization -
Petroleum and Coal
Products
Current Average
400
500
600
700
800
900
1000
1100
1200
1300
1Q95
4Q95
3Q96
2Q97
1Q98
4Q98
3Q99
2Q00
1Q01
4Q01
3Q02
2Q03
1Q04
4Q04
3Q05
2Q06
1Q07
4Q07
3Q08
2Q09
60
65
70
75
80
85
90
World Gold Demand (tonnes) (LHS) World Oil Demand (mb/d) (RHS)
Will Gold turn Black?
Resource Slack Not Equal Across Sectors
Resource slack in the U.S. primary metals market is currently 20%
below its historical average compared with about 4% in theagricultural sector and 3% in the energy sector. As a result, we
believe changes in demand for energy and agricultural commodities
will have a more substantial positive effect on prices for metals.
Data Source: FactSet, EcoWin, World Gold Council, U.S. Department of Energy
We believe oil will outperform gold in 2010 given the strength of oil
demand (-1.0% YoY) relative to gold demand (-33.6% YoY). Further,
since gold demand bottomed in 2Q09 gold prices have risen 21%
while oil is basically unchanged. The relative health of the oil market
compared to gold should begin to be reflected in their respective
prices in 2010.
Gold Market Fundamentals Weak
10
+9%
-1%
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7
9
11
13
15
17
19
21
23
1995 1998 2001 2004 2007 2010 2013
U.S. Europe (including UK) Asia ex Japan
Forecast
0%
1%
2%
3%
4%
5%
Asia ex-Japan U.S. Europe (including U.K.)
0%
5%
10%
15%
20%
25%
1995-2009 Oil Demand Compound Annual Growth Rate (LHS)
% of W orld Demand (RHS)
Will Gold turn Black?
Emerging Markets to Lead Demand Growth
In line with our expectation that emerging market demand will lead
the demand recovery, non-OECD Asia oil consumption now rankssecond behind the U.S. and, at current growth rates, will overtake
the U.S. as the largest consumer of oil in the world by 2012.
Data Source: U.S. Department of Energy
Emerging markets have driven oil demand growth since at least
1995. The developed countries still account for the majority of global
demand, however, we expect marginal demand from emerging
markets will drive oil prices higher.
Oil Demand Growth
10
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0
20
40
60
80
100
120
1/1/97 1/1/99 1/1/01 1/1/03 1/1/05 1/1/07 1/1/09
NASDAQ (Index) DJ REIT Index (Index) Oil (Index) Gold (Index)
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Will Gold turn Black?
Data Source: Bloomberg Financial L.P.
Gold Approached Bubble Levels in Late 2009
10
TechnologyBubble Real Estate
Bubble
OilBubble
GoldBubble?
Oil aBetterValue?
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One Step at a TimePatience and Discipline
Ten Themes for 200995% Accuracy
U.S. Economy Gets Worse Before it Gets Better; Stabilization in 2H09
Temporary Deflation Scare
1
2
3
Back in BlackU.S. Equities Rally
Treasury Turbulence Ahead
Corporate Bond Revival
4
5
6
U.S. Equities to Outperform International Equities7
Hedge Funds Stumble, but Regain Their Stride
Back to BasicsDividends, Valuations and Selectivity Matter
Commodities to Find a Bottom
8
9
10
This is an excerpt from the Top Ten Themes 2010 dated December 2009.
Correct Incorrect Partially Correct
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Investments in Foreign Countries - Such investments may be in countries that prove to be politically or economically unstable. Furthermore, in the case of investments in foreignsecurities or other assets, any fluctuations in currency exchange rates will affect the value of the investments and any restrictions imposed to prevent capital flight may make it difficult orimpossible to exchange or repatriate foreign currency.
Foreign Exchange/Currency - Such transactions involve multiple risks, including currency risk and settlement risk. Economic or financial instability, lack of timely or reliable financialinformation or unfavorable political or legal developments may substantially and permanently alter the conditions, terms, marketability or price of a foreign currency. Profits and losses intransactions in foreign exchange will also be affected by fluctuations in currency where there is a need to convert the product's denomination(s) to another currency. Time zonedifferences may cause several hours to elapse between a payment being made in one currency and an offsetting payment in another currency. Relevant movements in currencies duringthe settlement period may seriously erode potential profits or significantly increase any losses.
High Yield Fixed Income Securities - Investing in high yield bonds, which tend to be more volatile than investment grade fixed income securities, is speculative. These bonds are affectedby interest rate changes and the creditworthiness of the issuers, and investing in high yield bonds poses additional credit risk, as well as greater risk of default.
Hedge Funds - An investment in hedge funds is speculative and involves a high degree of risk, and is suitable only for "Qualified Purchasers" as defined by the US Investment CompanyAct of 1940 and "Accredited Investors" as defined in Regulation D of the 1933 Securities Act. No assurance can be given that a hedge fund's investment objective will be achieved, orthat investors will receive a return of all or part of their investment.
Commodities - The risk of loss in trading commodities can be substantial. The price of commodities (e.g., raw industrial materials such as gold, copper and aluminum) may be subject tosubstantial fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. Additionally, valuations of commodities may besusceptible to such adverse global economic, political or regulatory developments. Prospective investors must independently assess the appropriateness of an investment incommodities in light of their own financial condition and objectives. Not all affiliates or subsidiaries of Deutsche Bank Group offer commodities or commodities-related products andservices.
This document has been prepared for informational purposes only and is not an offer, or solicitation of an offer, to buy or sell any security, or a recommendation to enter into anytransaction relating to the products and services described herein. Before entering into any transaction, you should take steps to ensure that you understand and have made anindependent assessment of the appropriaten ess of the transaction in light of your own particular financial, legal and tax situation, investment objectives and level of risk tolerance, andyou should consult your legal and tax advisers to determine how these products and/or services may affect you.
This document contains forward-looking statements- that is, statements related to future, not past, events. In this context, forward-looking statements often address expected futurebusiness and financial performance, and often contain words such as expect, anticipate, intend, plan, believe, seek, or will. Forward-looking statements by their nature addressmatters that are, to different degrees, uncertain. Particular uncertainties that could adversely or positively affect future results include: the behavior of financial markets, includingfluctuations in interest and exchange rates, commodity and equity prices and the value of financial assets; continued volatility and further deterioration of the capital markets; thecommercial and consumer credit environment; the impact of regulation and regulatory, investigative and legal actions; strategic actions, including acquisitions and dispositions; futureintegration of acquired businesses; future financial performance of major industries; and numerous other matters of national, regional and global scale, including those of a political,economic, business and competitive nature. These uncertainties may cause actual future results to be materially different than those expressed in our forward-looking statements.
Although this document has been carefully prepared and is based on information from sources believed to be reliable, no representation is made that it is accurate and complete. Wehave no obligation to update or amend the information provided herein, and information is subject to change without notice.
Unless you are notified to the contrary, the products and services mentioned are not guaranteed by the FDIC (or by any governmental entity) and are not guaranteed by or obligations ofDeutsche Bank. These products are subject to investment risk, including possible loss of principal. The past performance of a product or service does not guarantee or predict its futureperformance.
Disclosures
Investment Strategy GroupLarry Adam, CFA, CIMAChief Investment StrategistTelephone (410) 895-4135
Facsimile (410) [email protected]
Megan HornemanInvestment StrategistTelephone (410) 895-4148
Facsimile (410) [email protected]
Ben SonleyInvestment Strategy AnalystTelephone (410) 895-4282
Facsimile (410) [email protected]
Jared McDaniel, CFAInvestment StrategistTelephone (212) 454-6814
Facsimile (212) [email protected]
Deutsche Bank means Deutsche Bank AG and its affiliated companies. Deutsche Bank Alex. Brown is the private client business of Deutsche Bank Securities Inc., asubsidiary of Deutsche Bank AG, which conducts investment banking and securities activities in the United States. Deutsche Bank Securities Inc., is a member of FINRA,NYSE and SIPC. Deutsche Bank AG. All rights reserved.
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