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2010 Investment Market Review Economic Recovery Transitions To Expansion. Investment Market Analysis January 2006. Worries over European sovereign debt levels and austerity programs lead to mid-year selloff

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2010 Investment Market Review

Economic Recovery Transitions

To Expansion

Investment Market Analysis January 2006


Worries over European sovereign debt levels and austerity programs lead to mid-year selloff

Assets appreciate in second half as economic data turns consistently positive and fears of a double dip recession subside

U.S. economy adds over one million jobs but the reality of a slow return to full employment sets in

Additional Federal Reserve asset purchases results in a strong year end rally in equities and other risk assets

Extension of Bush tax cuts is passed and additional stimulus enacted after lopsided mid-term election

Summary of 2010

2


Debt service ratio returning to normal levels
Debt Service Ratio Returning to Normal Levels programs lead to mid-year selloff

Household Debt Service Ratio

Creation of debt bubble sets the stage for financial crisis

Bubble bursts and households eliminate debt

Due to low interest rates, deleveraging, and foreclosures, households are returning to a more normal debt burden which increases their ability to both save and consume….

3


Continued monetary stimulus
Continued Monetary Stimulus programs lead to mid-year selloff

Quantitative Easing (2)

…..while the Federal Reserve mitigates the negative impact of this process by supplying liquidity to capital markets.

4


2010 Market Results programs lead to mid-year selloff

Several sectors (technology, consumer discretionary, consumer staples) are close to or above levels seen at the market top in October of 2007.

5


2010 market results
2010 Market Results programs lead to mid-year selloff

Real

Estate

Large Companies

Small

Companies

Foreign

Companies

Risk assets, such as equities and real estate, outperformed as markets continued to rally off the 2009 lows.

6


Long term diversified portfolios

Modern Portfolio Theory (MPT) widely utilized among sophisticated investors for last 50+ years

Widespread fear and rare events outside of normal economic cycles disrupt MPT in the very short-run

Diversification provides the foundation to participate in recovery after turbulent periods

Fear induced investment decisions and straying widely from a long-term plan can compound mistakes and negatively affect returns over time

Diversified portfolios outperformed broad-based indices through the recent market cycle

Long-Term Diversified Portfolios

7


Modern portfolio theory in practice
Modern Portfolio Theory in Practice sophisticated investors for last 50+ years

A diversified portfolio has had less volatility and has increased in value since the market peak

Diversified Portfolio is rebalanced quarterly and consists of the following indices: 22% S&P 500, 12% Russell 2000, 14% MSCI EAFE, 25% Barclays Capital Municipal Bond, 15% Barclays Capital U.S. Corporate Investment Grade, 6% FTSE NAREIT All REITs, and 6% Dow Jones UBS Commodity


The Cycle of Market Emotions sophisticated investors for last 50+ years

Point of Maximum

Financial Risk

“Wow, am I Smart.”

“Temporary setback-

I am a long-term investor.”

Optimism

“How could I have

been so wrong?”

How do you currently feel?

Point of Maximum

Financial Opportunity

Source: Janus

9

Point of Maximum

Financial Risk

“Wow, am I Smart.”

Euphoria

Anxiety

Denial

Thrill

Fear

Excitement

Desperation

Optimism

Panic

Capitulation

Relief

Hope

Despondency

Depression

Point of Maximum

Financial Opportunity


Tax Rates and Confidence sophisticated investors for last 50+ years

Extension of the Bush tax cuts and a payroll tax cut has provided a sentiment boost

Source: The Tax Foundation, J.P. Morgan Asset Management

However, confidence still in recession territory:

  • Unemployment stubbornly high

  • Housing remains weak

  • Continued deleveraging by households

  • Long-term fiscal worries

“It’s never paid to bet against America. We come through things, but it is not always a smooth ride.” – Warren Buffett

10


Equity Market Valuation sophisticated investors for last 50+ years

Equities appear cheap relative to bonds

???

Source: Standard & Poor’s, Moody’s, FactSet, J.P. Morgan Asset Management

The Fed wants investors to take risk…

Things for investors to consider:

  • Consistently rebalancing naturally leads to buying low and selling high

  • Hedged strategies can lower risk while still allowing investors to participate in up markets

  • Often, the best opportunities come from areas that have been shunned by the investing public

"Sustained deflation can be highly destructive to a modern economy and should be strongly resisted“ – Ben Bernanke (2002)

… but be careful of overvalued markets.

“…balance sheet policy…adds to household wealth by keeping asset prices higher than they otherwise would be” – Ben Bernanke (2010)

11


Lessons from 2010

The deleveraging process is long and can cause bouts of high volatility and uncertainty

It is very difficult to provide excess return through fundamental security selection in markets dominated by macro concerns

Markets dominated by fear and periods of high correlation among asset classes do not last forever and provide great opportunities to upgrade portfolios

The best performing markets are not necessarily found in the fastest growing economies

Corporations are adept at wringing out efficiencies and increasing profitability during difficult periods

Lessons from 2010

12


Investment themes for 2011

Yields on tax-exempt municipal bonds are compelling relative to Treasuries, especially after the 4th quarter 2010 selloff

Large-cap, multinational, quality “blue chips” are trading at a discount to the overall market

Investors continue to be attractively compensated for providing liquidity to companies that traditionally rely on the commercial banking sector

Non-U.S. dollar denominated and real assets (energy, real estate, etc.) can serve as a hedge against dollar debasement and domestic inflation while also providing income

Hedged strategies in both equities and fixed income markets allow for the ability to participate in continued expansion yet insulate portfolios from rising interest rates and increased volatility

Investment Themes for 2011

13


Risks to expansion

Conclusion of quantitative easing results in uncertainty and a decline in asset prices

Government stimulus wears off without the necessary increase in employment, resulting in very low growth rates

The housing market reaccelerates to the downside and banks fail to materially boost loan growth

Global growth engines (emerging Asia and Latin America) cool, depleting a major source of earnings growth for companies

Sovereign debt, expensive government programs and underfunded pensions roil capital markets

Geopolitical uncertainties related to instability, nuclear proliferation, terrorism, and protectionism come to a head, creating investor anxiety and fear

Risks to Expansion

14


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