3. 4Q:2009 Returns Credit “ Safe” Assets 2009 Returns Returns in USD Japan Gov’t EM EAFE US Global High Yield US CMBS US Gov’t Euro Gov’t Emerging Market Debt Global Corp Equities Past performance does not guarantee future results. As of December 31, 2009 Individuals cannot invest directly in an index. Please see slide 27 for index definitions. Source: Bloomberg, Barclays Capital, MSCI, S&P and AllianceBernstein Equities and Credit Sharply Higher in 2009…
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5. Confidence, While Still Weak, Is Improving G7 Confidence Measures Neutral Business Consumer Historical analysis does not guarantee future results. As of September 30, 2009 Source: Organisation for Economic Co-operation and Development (OECD)
6. Bank Willingness to Lend Is Becoming Less Restrictive Historical analysis does not guarantee future results. As of September 30, 2009 Source: Haver Analytics and US Federal Reserve Bank Willingness to Make Consumer Installment Loans
7. Significant Fiscal Stimulus Remains in Pipeline Estimates and “Still to Come” stimulus subject to change. As of December 31, 2009 *Includes realized tax cuts and amount paid out; China “realized” figure is an estimate. Source: CEIC Data, Congressional Budget Office, Recovery Accountability and Transparency Board, US federal agency financial and activity reports, and AllianceBernstein Fiscal Stimulus Total Stimulus Approved: US $787 Bil. US $790 Bil . “ Realized” as % of 2008 GDP: 2.0% 6.0% Realized* Still to Come
8. Inflation: Three Key Factors to Watch Historical analysis does not guarantee future results. Our framework marries the essential teachings about inflation from the major macroeconomic schools of thought with empirical evidence from a study of 180 countries over the past 40 years. Among other things, the empirical analysis examined those periods when a country went from low inflation (0%–5%) to high inflation (10%+) over a five-year span. Of these periods, 100% exhibited above-average money growth, 95% showed above-average wage growth and, qualitatively, 100% had aggregate demand exceeding aggregate supply. Source: AllianceBernstein Aggregate Demand vs. Supply Wage Growth Money and Credit Growth High Low Medium High Low Medium High Low Medium
9. As Growth Accelerates, Interest Rates Should Rise Historical analysis and forecasts do not guarantee future results. Projections may not come to pass. Historical data through September 30, 2009; forecasts through December 31, 2010 Official interest rate is a composite of 32 countries, including the developed economies and a sampling of emerging economies. Source: Haver Analytics, various central banks and AllianceBernstein GDP Growth Official Interest Rate Nominal World GDP Growth and Official Interest Rate
10. How Fast, and How Far? Official Interest Rates Percent Historical analysis and forecasts do not guarantee future results. Projections may not come to pass. As of December 31, 2009 *At year-end; 2010 forecasts are AllianceBernstein’s. Source: Bloomberg and AllianceBernstein
11. Long-Term Budget Projections Tend to Extrapolate Current Trends US Federal Budget US$ Billion Projection Made in 1990 for FY2000 FY1990 Actual Projection Made in 1999 for FY2009 FY1999 Actual FY2009 Actual FY2000 Actual Historical analysis and future projections do not guarantee future results. Projections may not come to pass. As of December 31, 2009 *Assumes a baseline GDP growth of 2.5% over 10 years Source: Office of Management and Budget FY2009 Actual Projection Made in 2009 for FY2019* FY2019 Actual ?
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13. The US Is Not the Only Driver of Consumption Historical analysis does not guarantee future results. Source: Haver Analytics, International Financial Statistics, World Bank and AllianceBernstein Emerging Markets’ Share of Global Real Consumption Growth Percent of Total 22% 29% 46% EEMEA Asia ex Japan Latin America Total Global Consumption Growth: 2.8% 3.9% 3.3%
14. We Believe The US Dollar Is Not at Risk of Losing Reserve Status Historical analysis does not guarantee future results. As of December 31, 2009 *Includes debt securities issued by nonresidents **Excludes interbank loans Source: Bank of International Settlements, European Central Bank, MSCI and AllianceBernstein Daily Currency Transactions US$ Billion US GDP as a Share of World GDP US Dollar as a Share of Capital Market Transactions International Debt Securities* Cross-Border Loans** Global Equities
15. Weak Dollar Is Attracting Foreign Investment to the US and Driving a Shift in Trade Flows Historical analysis does not guarantee future results. Left as of December 31, 2008. Right as of September 30, 2009. *Based on first three quarters Source: Bureau of Economic Analysis, Haver Analytics and US Federal Reserve Foreign Direct Investment in the US Real US Trade Deficit 09*
16. Innovation Should Continue to Drive Economic Growth and Create Investment Opportunities 1818 Bicycle 1827 Ohm's Law (Electricity) 1829 Steam Locomotive 1846 Anaesthesia 1860 Internal Combustion Engine 1876 Telephone 1880 Electric Lighting 1885 First Car 1893 Radio 1895 X-Ray 1903 Aeroplane 1923 Television 1928 Penicillin 1942 Nuclear Reactor 1953 Helical Structure of DNA Discovered 1971 Microprocessor 1973 Genetically Modified Organism & Personal Computer 1977 Mobile Phone 1985 DNA Finger Printing 1990 World Wide Web 2003 First Human Genome Sequenced 1865 Mendel's Law (basis of genetics) 1800 1900 2000 Source: AllianceBernstein Technological Revolutions
17. Equity Markets Look Attractive by Long-Term Measures, But Fairly Valued on Current Levels of Earnings Historical analysis and current estimates do not guarantee future results. As of December 31, 2009 Historical averages are calculated by averaging monthly values looking back 10 years. Individuals cannot invest directly in an index. Please see slide 27 for index definitions. Source: FactSet, MSCI and AllianceBernstein Price to Book MSCI World Price to Sales MSCI World Price to Earnings MSCI World 18.2× 17.7×
18. Global Profitability Is at a Cyclical Low MSCI World ROE* Historical analysis does not guarantee future results. As of December 31, 2009 *Defined as price/book value divided by price/earnings Individuals cannot invest directly in an index. Please see slide 27 for index definitions. Source: MSCI and AllianceBernstein Long-Term Average: 12.0% Current: 6.6%
19. Companies Have Started to Beat Earnings Estimates Positive 3Q:2009 Earnings Surprises* Historical analysis does not guarantee future results. As of December 31, 2009 *US represented by companies in the S&P 500, Europe by MSCI Europe and Japan by Nikkei 225; data are as of November 30, 2009. Individuals cannot invest directly in an index. Please see slide 27 for index definitions. Source: Bloomberg, MSCI, Thomson I/B/E/S and Bernstein
20. As Earnings Recover, Valuations Look More Attractive MSCI World Operating Earnings per Share 2010 Consensus Earnings Growth 28% Trend Past performance and current estimates do not guarantee future results. Actual earnings through December 31, 2008; 2009–2011 consensus estimates as of December 17, 2009 Individuals cannot invest directly in an index. Please see slide 27 for index definitions. Source: FactSet, Thompson I/B/E/S, MSCI and AllianceBernstein 2011 Consensus Earnings Growth 21% P/FE 17.6x 14.1x 11.7x
21. As Risk Appetite Returns, “Safe Havens” Underperform Returns (%) 2008 2009 Historical analysis does not guarantee future results. *At year-end; CBOE volatility index Categories represented by: Barclays Capital US Treasury Index; US dollar versus trade-weighted basket of currencies; Barclays Capital Global Aggregate–Corporates Index, hedged into US dollars; S&P GSCI Total Return Index; and MSCI World, hedged into US dollars Individuals cannot invest directly in an index. Please see slide 27 for index definitions. Source: Barclays Capital, Bloomberg, CBOE, MSCI and S&P US Dollar US Treas Global Corps Global Equities Comm-odities US Dollar US Treas Global Corps Global Equities Comm-odities VIX* 40.0 VIX* 21.7
22. Company- and Industry-Specific Factors Increasingly Drive Stock Performance Historical analysis does not guarantee future results. As of December 31, 2009 Individuals cannot invest directly in an index. Please see slide 27 for index definitions. Source: Credit Suisse, MSCI and AllianceBernstein MSCI World Intra-Index Correlation of Performance Less Stock-Specific More Stock-Specific
23. The Spread Opportunity Has Been Largely, Although Not Fully, Captured Global Corporate Bond Spreads to Treasuries 2007–2009 Dec 2009 Dec 2008 Dec 2007 High Yield Inv. Grade Historical analysis does not guarantee future results. As of December 31, 2009 Individuals cannot invest directly in an index. Please see slide 27 for index definitions. Source: Barclays Capital and Merrill Lynch
24. Sound Research Is a Must In a Lower-Yield Landscape Historical analysis does not guarantee future results. As of December 31, 2009 Individuals cannot invest directly in an index. Please see slide 27 for index definitions. Source: Barclays Capital and Merrill Lynch Global Investment-Grade Corporates (%) Highest Yielding Issue Median Yield Global High Yield (%) 86.3 Lowest Yielding Issue
25. The Worst Year in Market History Followed By One of the Best Number of Positive Years: 30 75% Number of Negative Years: 10 25% Historical analysis does not guarantee future results. As of December 31, 2009 Individuals cannot invest directly in an index. Please see slide 27 for index definitions. Source: MSCI and FactSet AllianceBernstein Annual Stock Market Returns MSCI World Index Percentage Total Return -20 to -10 2002 20 to 30 0 to 10 1973 1990 2000 2001 1970 1977 1971 1972 1974 1981 1982 1976 1980 1992 1984 1978 1983 1994 1979 1988 2005 1987 1993 2007 1989 1995 1991 1998 1996 1999 1997 2006 -40 to -30 -30 to -20 -10 to 0 10 to 20 40 to 50 1975 1985 2003 30 to 40 -50 to -40 2004 1986 2009 2008
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27. A Word About Risk Past performance is no guarantee of future results. The investment return and principal value of an investment in any Fund will fluctuate as the prices of the individual securities in which they invest fluctuate, so that shares, when redeemed, may be worth more or less than their original cost. Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be “value” stocks are able to turn their business around or successfully employ corrective strategies that would result in stock prices that rise as initially expected. Investments in foreign securities may magnify fluctuations due to changes in foreign exchange rates and the possibility of substantial volatility due to political and economic uncertainties in foreign countries. Because a Fund may invest in emerging markets and in developing countries, an investment also has the risk that market changes or other factors affecting emerging markets and developing countries, including political instability and unpredictable economic conditions, may have a significant effect on a Fund's net asset value. Investing in non-US securities may be more volatile because of political, regulatory, market and economic uncertainties associated with such securities. These risks are magnified in securities of emerging or developing markets. While a Fund may invests principally in common stocks and other equity securities, in order to achieve its investment objectives, a Fund may at times use certain types of investment derivatives, such as options, futures, forwards and swaps. These instruments involve risks different from, and in certain cases, greater than, the risks presented by more traditional investments. These risks are fully discussed in each Fund’s prospectus.
Thank you ---- and thank you all for joining me today: Now that the final chapter has been closed on 2009, it will surely be remembered as a remarkable year. In only twelve months, capital markets experienced both the depths of a decline driven by the credit crisis and the relief of a surprisingly strong recovery. Markets haven’t come all the way back to their previous heights yet, but 2009 ended up as a very good year for investors. As we enter 2010, here’s how we see the big picture.
The markets clearly responded to the economic recovery, however… The timing and execution of reigning in large stimulus measures will be a crucial and delicate task The financial crisis has altered the global economic landscape… … but identifying companies and industries that benefit from these changes should reward active managers Transition: Let’s now review how the markets performed in the fourth quarter and for all of 2009.
The broad market upturn that began in early March, and continued during the fourth quarter, led to impressive gains for 2009. In fact, the S&P 500 Index’s return of 26% for the calendar year was its best showing since 2003. Positive equity returns were pervasive in the fourth quarter, with the emerging markets and EAFE indices up over 8% and 2%, respectively. Emerging markets were especially strong for all of 2009, gaining 79%. Global bonds also continued to perform well, adding to their returns that either rivaled or exceeded results generated by global equity indices for the year. As fears of the most pessimistic default scenarios dissipated, investors steered capital away from “risk –free” areas of the credit markets, whose yields were scant. Global high-yield bonds provided the best returns for both the quarter and all of 2009, while even global investment-grade bonds produced a 17% return for holders of that asset class. And as investors consistently embraced risk throughout the year, returns in the government bond area lagged other segments of the credit market by a wide margin. Transition: The combination of credit markets healing, and an improved economic backdrop were key drivers to these favorable results, as investors took a more balanced view of risk and return. While we cannot say that such strong market returns will be repeated in 2010, we are confident the improved trend in economic growth will continue.
Evidence continues to accumulate that the world is rebounding from a widespread recession. The global economy likely shrank by 2.3% in 2009; in 2010, we expect it to expand by 3.5%, which would represent its best calendar-year showing since before the crisis. Developed economies like the US, Europe and Japan will recover, and emerging markets will continue to lead the way with a strong expansion. The chances of recovery have been improved by a rapid rebound in global manufacturing, which could eventually lead businesses to begin hiring again. New jobless claims have fallen and leaner companies are increasingly tapping temporary workers to help meet demand—a positive development for eventual full time job creation. However, as the economic recovery continues, it’s likely to take on a different shape than past turnarounds. The tides of the world’s economy have changed: sizable government stimulus packages are bolstering the early stages of the rebound, consumption is becoming more global and a weak dollar is rebalancing capital flows and trade. Transition: It’s not surprising that better general business conditions and the beginnings of improvement in the employment environment have helped to instill rising confidence among both businesses and consumers.
The survey numbers you see in this display reflect the confidence level in the G-7 developed nations (US, Canada, UK, France, Germany, Italy and Japan). Now, I certainly wouldn’t call these numbers optimistic, but they have improved steadily from the height of pessimism in early 2009. And confidence is a critical element in a sustained recovery—businesses that see brighter prospects ahead are more likely to grow and expand, and less pessimistic consumers are more likely to spend money on new cars, new appliances, vacations, entertainment and other activities that help underpin economic growth. Of course, to make those outlays, many consumers need to tap into credit by taking out loans from banks. First, they have to want to borrow, and second, banks have to be willing to lend to them. The lending environment is still mixed, but it is showing meaningful signs of improvement. Transition: Consumer demand for loans continues to weaken, as developed-market households remain relatively conservative with their finances. But at least banks appear to be growing more willing to lend today.
The Federal Reserve regularly surveys loan officers at major banks in the US—domestic banks and US branches of foreign banks. In the most recent survey from October, you can see a gradual improvement in banks’ attitudes toward consumer lending. Of course, the standards for approving new borrowers are still much tighter than they had been. Banks indicated that they continued to tighten standards and terms over the past three months on all major types of loans to businesses and households, although the net percentages of banks that are still tightening continued to decline. So, overall, the picture is mixed, but trending toward improvement. But consider also that bank lending historically lags economic recoveries. If economic growth ultimately translates into job creation, as we suspect, this segment of the credit markets will serve to sustain an improved growth path to the benefit of many when it resumes. Transition: Bank lending on its own does not serve as a catalyst for economic turnarounds, but it would be yet another form of stimulus to aid economic activity. This would add to the already substantial amount of stimulus that remains to be deployed.
Massive fiscal stimulus, on a global scale, has certainly played a role in fighting recession, and it is not over. Despite this, some investors fear an economic relapse as government stimulus has run its course. But the reality is that much spending still remains on tap. (“Realized” represents the amount already distributed/awarded plus tax receipts not received due to stimulus-related tax cuts—i.e., money that would otherwise have been received to date.) Almost two-thirds of the $787 billion US fiscal stimulus is yet to be disbursed. In China, roughly half of the government’s fiscal relief is still on the way—funds for building railways and low-income housing, improving rural infrastructure and tackling a host of other initiatives. The positive affect of all of this spending is that it can, and historically has, aided economic growth. However, if it is not pared back in an orderly manner once the economy materially strengthens, too much stimulus can lead to runaway inflation. Transition : Whether this occurs or not is a key source of contention among investors.
In our view, near term, core inflation is not a threat. And we dimension its impact by monitoring these three gauges. Let’s examine them one at a time: Aggregate Demand vs. Supply: Often referred to as capacity utilization, this measure remains at all-time lows around the world. In the U.S., it stands at roughly 70%. Historically, only when this measure has hit 85% have we witnessed price increases due to capacity tightness. Wage growth has been constrained, as U.S. wages and salaries have risen just 1.5% for the 12 months ending September. Also with unemployment remaining stubborn globally, this has also prevented a wage spiral from occurring. Money and credit growth: While central bank balance sheets have grown dramatically, these funds have not been circulating in the economy due to a muted lending environment, which has hindered inflation. We acknowledge that headline inflation in the US is likely to rise, as volatile food and energy prices increase from the low marks that were established in the latter part of 2008. But the above three core measures are the most vital in our view. Transition : Such price increases are a byproduct of higher demand, due to improving, global economies. And as growth accelerates, interest rates are likely to rise from their historic lows.
With signs of stronger and broader growth, concerns are now shifting to “exit strategies”. Specifically, how will policymakers around the world withdraw the massive doses of monetary and fiscal stimulus to prevent inflation from becoming a problem? If the recovery gains momentum in 2010, as we expect, central banks will be forced to raise official rates from the current extreme low levels. The chart illustrates the historical relationship between nominal world GDP growth and official rates. There was a sustained period (2002–2008) where official rates were substantially below nominal growth (i.e., stimulative policy), which arguably contributed to the housing bubble. In our view, policy rates must move back toward nominal GDP to avert the next bubble. We expect the Fed to start to raise official rates in the US by the end of the second quarter. Transition : But how fast will they rise, and how far will they go?
Short-term rates are being held very low to encourage the flow of capital. The light blue bars show our forecasts for short-term interest rates in key regions for 2010. The green bars indicate the average short rates between 2003-2007. In our view, the positive momentum building in the US economy makes it possible that the Fed could move to tighten monetary policy relatively early in 2010. We also expect rates to jump up in other major economies. But there are a few important things to note about rising short-term rates. First, the fact that rates are being increased is a good sign that the global economy is getting healthier and needs to be managed. Also, when they do increase, it will be from extraordinarily low levels, and short-term rates should stay well below long-term rates, leaving strong incentives for investment and growth. Some worry that waiting too long to raise rates could cause inflation to spiral out of control; others fear that raising them too far or too fast will choke off recovery. But even if rates rise materially from historic lows—and we believe they will—such an interest-rate environment should still support economic activity. Transition : Similar to low interest rates, the objective of the large fiscal stimulus packages enacted globally was to foster economic growth. However, concern is high regarding the negative implications of budget deficits in the U.S., and how long such debt will linger.
Budget deficits bear monitoring. Currently-high deficits are a function of increased fiscal spending coupled with collapse in growth, and many expect this posture to remain in place for some time. However, history shows that people tend to “anchor” their expectations to today’s environment, and the actual fiscal position in the future can be markedly different from what one anticipates. A look back confirms this. In 1990, the expectation was the then U.S. budget deficit would worsen over that decade. By 2000, the U.S. was actually at a budget surplus! Conversely, when the U.S. was at a budget surplus in 1999, the projection was for this to more than triple by 2009. However, the end result is where we stand today--- a large deficit . As shown on the far-right set of bars, the Office of Management and Budget (OMB) forecasts that the deficit will be roughly cut in half by 2019. This assumes a return to modest GDP growth of 2.5% over the next 10 years. If this is the case, the deficit would equate to 3.4% of overall GDP. But consider that the OMB’s 10-year, 2.5% baseline GDP growth estimate is well below the U.S.’s 3.3% historical average trend growth rate, and economic growth can have a measurable impact on budget figures. For example, should GDP growth average 3% over the next decade, the deficit would equate to just under 2% of GDP. Transition : Consequently, economic growth rates and the highly political nature of fiscal policy adds to the complexity of deficit reduction; uncertainty surrounding deficits may be with us for some time. But this, and other uncertainties can lead to significant investment opportunities.
Managing uncertainty is an ever –present challenge for any investment manager. Currently, some of the main areas of angst include: 1) the debt-strapped consumers of the developed economies (particularly in the U.S.), and the hurdle this poses for them to resume spending; 2) a weak U.S. dollar that has led to lower confidence in this nation; and, 3) increased levels of regulation and fear that might stifle economic growth. While we acknowledge these risks, we also feel there are meaningful offsets to them that are not being widely embraced---if we are correct, this spells opportunity! We will soon show why we feel a growing, emerging markets middle class is key to global consumption growth. Secondly, the falling U.S. dollar was needed to correct an unhealthy trade flow imbalance. Lastly, while regulation is likely to be heightened in major sectors such as financial services, our view is innovation and strong productivity will generate successful, new industries and companies investors can benefit from. Transition: Let’s address the first concern; the state of global consumption.
Massive stimulus efforts are creating a new pattern for this recovery, and so is global consumption. With the US and other developed-economy consumers remaining under pressure due to high debt levels and record unemployment, many wonder how sustainable the recovery is. After all, the US and other developed consumers have traditionally led the way back from economic downturns. But the role of emerging market consumers is growing. In the 1990s, emerging markets accounted for 22% of the world’s consumption growth. Since 2006, that share has doubled to nearly half, and is well balanced among diverse regions including Asia, Eastern Europe and Latin America. (Accordingly, this shift is not all due to China’s expansion). Transition: Therefore, the global economy is far less dependent on the US consumer, thanks to rapid consumption and economic growth in emerging regions. And a weaker US dollar has made it more affordable for foreign consumers to purchase US goods, as their relative purchasing power has increased.
But the weak US dollar has many fearing that it may lose its status as the world’s undisputed reserve currency. We think these fears are overblown. The dollar is by far the most liquid currency in the world. You can see this in the left-hand chart, which shows that the dollar is much more popular than the Euro or yen in currency transactions. In fact, as indicated in the right-hand chart, it accounts for a disproportionate share. While the US contributes about one quarter of world GDP, the dollar is used in as much as half of the world’s currency transactions in the capital markets. It’s difficult to unwind a reserve currency that’s so deeply entrenched in international exchange. And while our near-term outlook for the US dollar is for continued weakness relative to other currencies, we maintain these and other factors will continue to support the dollar’s role as the global reserve currency in the near and medium terms. Transition : However, a sliver lining to a weak dollar is that it has rebalanced capital flows and trade. .
A weaker dollar has boosted capital investments from other countries. Foreign direct investment in the US has reached almost $840 billion over the past three years, most of it from industrialized economies, led by Canada, Germany, France, Australia and Japan. Mostly, foreign companies have acquired existing businesses to enter the market, although some have established new companies in the US. A weaker dollar is also changing the way companies think about supplying these businesses in the US. It’s making it much more economical for Japanese and European companies to produce goods in the US as opposed to shipping goods there before assembling and distributing them. It’s also making US goods much cheaper for consumers in other nations, while at the same time making foreign goods more expensive for US consumers. As the US imports less and exports more, the trade balance has taken a favorable turn, falling considerably. Now, to be fair, the US economic slowdown and declining consumption have also played a big part in reducing the deficit, and some of this flow is expected to reverse as the recovery progresses. But the deficit probably won’t return all the way back to its previous magnitude in the near-term.
A third concern for investors is that an onslaught of trade protectionism, climate change regulations and other government regulation will stifle the ability to innovate. In other words, people worry that everything that can be invented has been invented. We don’t share this concern. This chart looks at 200 years of innovations, and no one would argue that the world hasn’t seen a lot of rules and regulations along the way—particularly in the twentieth century. Whether it’s the nuclear reactor, DNA finger printing or human genomes, many innovations have been produced—even though regulation marches on. So, to sum up what we’ve covered so far: The economic recovery is gaining steam. There are still sizable risks related to fiscal and monetary exit strategies. Investors are experiencing a lot of anxiety about the future. And these worries continue to generate investment opportunities. Transition: Let’s turn to the capital markets and take a look at how these opportunities are being reflected in both stock and bond prices.
By long-term measures, whether it’s price to book value or price to sales, stocks are cheaper than they’ve been on average, over the past decade. But based on current earnings levels, stocks don’t seem as attractive—they look to be roughly at fair value today, based on their price to earnings ratio. Of course, earnings are still extremely depressed as the corporate sector emerges from recession. Transition: In fact, they’re near a cyclical low point.
Over the long term, there’s been a very strong relationship between economic growth and corporate profits. Growing economies drive growing earnings. But profitability rises and falls with economic growth over time. Over the past two decades, profitability has averaged about 12%, but it’s roughly half of that today. But given the historical relationship between economies and profits, it’s highly unlikely that profitability will remain this low. Transition: In fact, there are already signs that profits are beginning to rebound from their crisis-fueled depths.
Record numbers of companies exceeded analysts’ earnings expectations in both the second and third quarters, driving price gains. But there’s been an undercurrent of doubt in this stellar earnings performance. To this point, earnings surprises have largely been attributed to a deep round of corporate cost-cutting. Now, markets are waiting eagerly for a rejuvenation in demand that will drive revenue growth. But where will those revenues come from? One important source is likely to be renewed capital spending in many industries. As the economy turned downward, companies tightened their purse strings. They curtailed spending and capital investments, holding off on buying new computers and vehicles, and delaying or forgoing a host of other long-term capital outlays. It’s highly unlikely that this situation will remain. Business equipment can’t last forever—vehicles break down and office computers must eventually be upgraded. As companies begin to open the tap on spending, it will translate into new sources of revenue for the economy. Transition : Further, revisions for earnings and revenues turned positive in late 2009—evidence that analysts see earnings gains ahead.
The consensus forecast is for 28% earnings growth in 2010 and 21% in 2011. That may seem optimistic—but that simply gets earnings back to their long-term trend, not to the peaks of 2006 or 2007. And remember—you can have large percentage gains when numbers increase modestly off of very low bases. As you see in the numbers along the bottom of the chart, stock valuations look substantially more attractive based on these rising earnings. Transition : The combination of improving earnings, economic growth and healthier credit markets has led to an increase in investors’ risk appetites. And a decline in volatility has acted as a tailwind for riskier asset classes.
At the height of fear in late 2008, measures of volatility such as the Chicago Board Options Exchange Volatility Index (VIX) attained record highs. (The VIX represents expectations of US equity market volatility over the next 30 days, implied by the pricing of options on the S&P 500 futures contract). In fact, the VIX peaked at 81 in November 2008, and its historical average is approximately 20. As you will note on the left chart, it was double that during all of 2008, when investors were fleeing risk at any cost. Risky assets responded in kind by tallying broad-based, negative returns. Fast forward to 2009, and you will see on the right-hand chart that the VIX’s average was approximately half of 2008’s levels. Investor risk budgets rose, as did riskier assets. Confidence among market participants was reinforced further as the markets steadily increased following the trough reached in March of last year. Our view is that lower levels of volatility, coupled with reasonable market valuations, provides a favorable backdrop for investors to maintain their long-term allocations to equities. Transition : But as global equity markets move to the next stage, a disciplined research approach will be needed to discern winners in the new landscape.
This chart shows the intra-index correlation of stocks that comprise the MSCI World Index going back to 2002. When the green line is at high levels, this essentially means that the general trend of the market (or beta), largely accounts for a stock’s return. This was especially acute during the financial crisis, as stocks’ correlation rose in a negatively-performing market when risk mitigation was the aim. As the markets have regained a fair amount of lost ground, and the correlation between companies has lessened, we feel the environment is moving to a phase where stocks’ returns will be driven more by stock-specific factors (or alpha), versus market rends in aggregate. In such a dynamic setting, companies with stronger fundamentals, more innovative technologies or better strategies will capitalize on a changed economic landscape and move to the forefront. To successfully identify these firms, investors will have to be more selective, with diligent research pointing the way to the opportunities of tomorrow. Transition: Effective research will now also be key to generating returns in the fixed-income area.
We see opportunities in corporate bonds, even though yield spreads have fallen sharply, particularly in riskier, higher-beta securities. This is illustrated by comparing the yield curves on the chart. December of 2008’s yield curve gapped out measurably from that of December 2007, as a result of rising default expectations emanating from the credit crisis. Once these worst-case-scenario fears abated, the corporate bond yield curve fell dramatically from its highs. Spreads on higher-beta corporate bonds (with BB-rated credits as a proxy) have compressed from about 1,400 basis points in 2008 to 506 basis points to comparable maturity Treasury securities at year end 2009. We’re still seeing plenty of attractively valued bonds, because fundamental risk has declined, too. But because the higher-beta securities offer much smaller yield spreads, we’ve taken some risk off of the table in these bonds. We’ve also increased the diversification of our corporate bond portfolios. Transition: But arriving at this diversification is not an easy task in this lower-yield environment.
Just as the yield curves on the prior slide moved dramatically over the past three years, so to did the dispersion of yields on corporate bonds. The grey bars show the range of the highest and lowest yielding global corporate bond issues from 2007 to 2009. Investment-grade bonds are shown on the left, while high-yield bonds are shown on the right. Now that the range of yields in both sectors has narrowed significantly from those of December 2008, choosing between winners and losers in the current setting has become more difficult. This is precisely why a sound, research-oriented approach in this asset class is a bond manager’s best ally. Attractive bonds still remain to be found in our opinion, but as with stocks, those that perform well will be driven more by industry or company-specific factors; and not as much by a falling yield climate. Transition : Maintaining discipline, and not letting one’s emotions dictate their investment strategy in one of the most frightening periods proved rewarding for bond investors last year. The same can be said for stock investors.
Once the details of 2009 have faded from memory, history will show it to be a strong calendar year for equity markets…and a stark contrast to the year that preceded it. One of the worst years ever for stocks was followed by one of the best—a potent reminder of how important it is to stay invested, even through very difficult times. Many equity investors suffered steep losses in the extended downturn that started in October 2007, and they’ve yet to regain all the ground they lost. The market’s 73% return from its bottom has allowed investors to recoup a little more than half of the wealth they lost in stocks. Investors who had faith in the market’s ability to bounce back, kept their money at work instead of abandoning their long-term strategy. Those investors are better off today than they were twelve months ago. Of course, the way forward won’t be without plenty of twists and turns. While the long-term path of equity markets has been upward, the journey has often been interrupted by bear market declines—sometimes substantial ones. As long as stock markets exist, there will be exhilarating rallies and harrowing sell-offs. But we believe that maintaining an asset allocation that is appropriate for your risk tolerance and long -term goals, while periodically checking in to ensure that your portfolio still makes sense for you, will continue to be a winning strategy.
Friday 5 February 2010 Friday, February 5, 2010 Read to audience
![The information herein reflects prevailing market conditions and our judgments as of the date of the presentation, which are subject to change. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. Opinions and estimates may be changed without notice and involve a number of assumptions which may not prove valid. Neither this presentation nor any of its contents may be used for any purpose without the consent of AllianceBernstein. Investment Products Offered: Capital Markets Outlook New Landscape Generates Opportunities December 31, 2009 ,[object Object],[object Object],[object Object]](https://image.slidesharecdn.com/4qcmopptclient-12653987640399-phpapp01/85/Capital-Market-Outlook-1-320.jpg)
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