Investment Directions Monthly Market Outlook November 15, 2012
INVESTMENT DIRECTIONS [ 2 ] Macroeconomic OverviewTABLE OF CONTENTS With the US elections now over, investors’ attention turns to the potential fiscal cliff. However, with essentially a status quo government, the possibility of gridlock over keyGlobal Regions...................................4 economic issues remains. We still believe that the market is unprepared for a trip over the fiscal cliff with economic and analyst estimates suggesting that most investorsGlobal Sectors...................................6 believe it will be avoided. As such, we would remain cautious—expect to see heightenedFixed Income Sectors.......................7 volatility and market movement based on news related to clues on how the two parties are likely to behave, as we saw the day after the election, rather than longer term trends. Since peaking in September, US equity market prices have traded lower, down 5.8% from September 16 through November 12. Interestingly, non-US stocks dramatically outper-What’s New formed in October.Upgrade:• France to overweight from neutral Given the risk that the United States may experience a recession in 2013 if the country• lobal technology to overweight G plunges over the fiscal cliff, and that volatility is likely to rise on the lingering uncertain- from neutral ty, we continue to favor investments that potentially offer some downside protection:Downgrade: high-quality international dividend-paying stocks, global mega capitalization stocks• Norway to neutral from overweight (mega caps), municipal bonds, and minimum volatility funds.• Taiwan to neutral from overweight ontributing to negative sentiment in the markets is the fact that the earnings season C• Singapore to neutral from overweight has proven to be mediocre and companies’ guidance for fourth quarter, for the most• S industrials to neutral from U part is negative. Third-quarter earnings were down around 2%, marking the end of 11 overweight quarters of earnings growth. While gross domestic product growth did accelerate in the• uropean financials to underweight E third quarter from an anemic 1.3% in the second quarter to a more respectable 2%, the from neutral recovery is not really strong enough to generate much revenue growth. Globally, we still• igh yield credit to underweight H from neutral believe the remainder of the year will see sluggish, but positive, growth. We continue to watch events in Europe closely. Lowered growth forecasts in Europe, along with impasse over the aid package to Greece, underscore how Europe is not out of the woods yet, despite aggressive actions this summer by the European Central Bank (ECB). Risk Appetite Dial Still, we continue to favor northern European countries, such as Germany, the Nether- lands and, thanks to recent underperformance, now France, over the southern countries. Overall, the road ahead is still likely to be rocky. We continue to have an overweight long-term view of global equities, especially relative to bonds. We also prefer to get equity exposure through select developed and emerging markets that have robust last month growth prospects, less debt and fewer banking sector problems. Within fixed income, we like US spread products such as investment grade and municipal bonds; however, givenLow High compressed spreads and slow growth forecasts, we have downgraded our short-term view of high yield bonds to underweight. We also continue to favor holding a strategic long-term allocation to commodities including gold, a beneficiary of the likely continua-Our global market risk appetite measureaccounts for ongoing shifts in investor tion of the Federal Reserve’s (Fed’s) more accommodative monetary policy with thesentiment around the macro fundamen resulting inflation concerns, and as a potential safe haven around the fiscal cliff.tals that form the basis for our near-term investment views. Please see the Figure 1: Longer-Term Global Asset Allocationappendix for an explanation of our riskappetite measure methodology. Underweight Neutral OverweightInvestor sentiment has turned marginallynegative since the last Investment Direc- Global Equities ntions update. The deterioration was mainly Treasury Bonds ndriven by falling stock market prices, leddown by the mixed third-quarter earnings Corporate Bonds nseason, and later by renewed fear over the Municipals nUS fiscal cliff and a deeper-than-expected Treasury Inflation-Protected Securities nrecession in Europe. On the other hand, in-vestors continue to seek credit risk in thesearch for yield, driving the spread between This material represents an assessment of the market environment at a specific time and is not intended to be a forecast oflow-quality and high-quality US corporate future events or a guarantee of future results. This information should not be relied upon by the reader as research, investmentdebt to a four-month low. Meanwhile, US advice or a recommendation regarding the iShares Funds or any security in particular. This information is strictly for illustrative and educational purposes and is subject to change.economic activities have shown broad-based improvement from previous monthswith employment, production, sales andorders providing the tailwinds.
INVESTMENT DIRECTIONS [ 3 ]Figure 2: iShares Investment Strategy Group Near-Term Outlooks Global Region Underweight Neutral Overweight Related iShares ETF Tickers Developed Markets Global Equities x ACWI, HDV, IOO, OEF, IDV, URTH, ACWV Developed Markets x EFA, IDV, ACWX, EFAV, SCZ Australia x EWA, EPP, EWAS, DVYA Canada x EWC, EWCS France x EWQ Germany x EWG, EWGS Hong Kong x EWH, EWHS Italy x EWI Japan x EWJ, SCJ Netherlands x EWN Norway x ENOR Singapore x EWS, EWSS Spain x EWP Sweden x EWD Switzerland x EWL United Kingdom x EWU, EWUS United States x EUSA, IWV, IVV, USMV Emerging Markets Emerging Markets x EEM, EEMV, DVYE, EEMS Brazil x EWZ, EWZS China x MCHI, ECNS India x INDY, INDA, SMIN Indonesia x EIDO Mexico x EWW Russia x ERUS South Africa x EZA South Korea x EWY Taiwan x EWT Global Sector Underweight Neutral Overweight Related iShares ETF Tickers Consumer Discretionary x Consumer Staples x IYK, KXI, AXSL Energy x IXC, FILL, EMEY, AXEN European Financials x EUFN Financials x IYF, IXG, AXFN, EMFN, EUFN, FEFN, IAT Healthcare x IYH, IXJ, AXHE Industrials x IYJ, EXI, AXID Global Technology x IXN, AXIT, AAIT, IYW, SOXX Materials x IYM, MXI, AXMT, EMMT, RING, PICK, SLVP REITs x ICF, IYR Telecommunications x IXP, AXTE, IYZ US Regional Banks x IAT US Industrials x IYJ US Retail x N/A US Technology x IYW US Utilities x IDU Utilities x IDV, JXI, AXUT Fixed Income Sector Underweight Neutral Overweight Related iShares ETF Tickers Emerging Markets x EMB, LEMB, CEMB, EMHY High Yield Credit x HYG, HYXU, GHYG, QLTB, QLTC LQD, FLOT, QLTA, MONY, ENGN, AMPS, CSJ, Investment Grade Credit x CIU, CFT, CLY, QLTA Mortgage-Backed Securities x MBB, GNMA, CMBS Municipals x SUB, MUB Non-US Developed Markets x ISHG, IGOV TIPS/Global Inflation-Linked x STIP, TIP, GTIP, ITIP US Treasuries x SHY, IEI, IEF, TLH, TLT, GOVT, SHV Global Style Underweight Neutral Overweight Related iShares ETF Tickers Global Mega Caps x OEF, IOO, HDV, DVY, IDV Small Caps x IWMThis material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This informationshould not be relied upon by the reader as research, investment advice or a recommendation regarding the iShares Funds or any security in particular. This information is strictly forillustrative and educational purposes and is subject to change. This information does not represent the actual current, past or future holdings or portfolio of any BlackRock client.
INVESTMENT DIRECTIONS [ 4 ]Global RegionsDeveloped Markets: With the US election behind us, President region from 1% to 0.1%. While recognizing that slower growth forObama now faces negotiations with Congress to avoid the so-called Germany seems inevitable, we believe that its valuation stillfiscal cliff, which automatically comes into effect on January 2, 2013 looks favorable. In the longer term, the German corporate sectorif no action is taken. The market sold off sharply post-election with is well-positioned to gain from emerging market growth and asentiment led down by Fitch’s warning of a possible rating down- competitive domestic labor market.grade. The good news is that lawmakers are aware of the economic We are also upgrading France from neutral to overweight, whileimplications of the fiscal cliff, but with a split Congress, the path to downgrading Norway from overweight to neutral. Since thecompromise will be anything but smooth. Adding to the uncertainty ECB’s bond purchase program announcement in September,has been a mixed third-quarter earnings season that underscores which mitigates the tail risk of a eurozone break-up andthe divide between subdued corporate sentiment and a better mood compresses risk premia, French equities have lagged otheramong consumers thanks to housing and labor market improvement. eurozone countries, resulting in attractive valuations. In ourOur view on the United States has been neutral in light of rich view, the “recession discount” fueled by the ambitious budget,valuations and heightened event-driven uncertainty. which aims to cut the fiscal deficit to 3% in 2013 mostly via tax increases, is already largely priced in. Meanwhile, the deteriorat- Europe, growth In fears have intensified amid worrying signs ing news flow from Germany has increased the odds that EU that the festering debt crisis is taking a toll on Germany, and the policymakers are more willing to let the ECB operate on looser European Commission cut its 2013 growth forecast for theFigure 3: Global Region Near-Term Outlooks and the Factors Behind Them* Global Region Valuations Growth Profitability Risk/ Our View Related iShares Developed Markets (P/B) Sentiment Underweight Neutral Overweight ETF Tickers EWA, EPP, Australia + + EWAS, DVYA Canada – – + EWC, EWCS France + – – EWQ Germany – – + + EWG, EWGS Hong Kong + + EWH, EWHS Italy + – – EWI Japan + – – EWJ, SCJ Netherlands + – – EWN Singapore – EWS, EWSS Spain + – – – EWP Sweden – + + + EWD Switzerland – – + EWL United Kingdom – + EWU, EWUS EUSA, IWV, IVV, United States + + + USMV Emerging Markets Brazil + – – EWZ, EWZS China + + MCHI, ECNS INDY, INDA, India + + SMIN Indonesia + + EIDO Mexico – + – EWW Russia + – – ERUS South Africa – + – EZA South Korea + EWY Taiwan EWT – unattractive + attractive neutral current underweight outlook current overweight outlook current neutral outlook previous month (if not shown – same as current)* Please see appendix for an explanation of our factor methodology. ** Due to a confluence of factors, country views may be in the same spot on the chart though the countries’ outlooks aredifferent. Please see Figure 2 for official outlooks. ***Figure 3. tracks countries with market capitalization that is above the median market value of MSCI All Country investment universe.This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This informationshould not be relied upon by the reader as research, investment advice or a recommendation regarding the iShares Funds or any security in particular. This information is strictly for illustrativeand educational purposes and is subject to change. This information does not represent the actual current, past or future holdings or portfolio of any BlackRock client.
INVESTMENT DIRECTIONS [ 5 ] monetary policy to support growth, which we would expect to Figure 4: Valuations and Market Returns–Price/Book disproportionately benefit French equities. While downside risks 2.5 remain within the banking sector, the broad French market is 2.2 2.2 2.1 2.1 2.0 well diversified with no single sector accounting for more than 2.0 16% of the index, and the deep discount in non-financial sectors 1.7 1.6 1.6 1.6 compared to peers in Germany and the rest of developed Europe 1.5 1.4 is in our view hard to justify. Since late January, Norway has 1.3 1.3 outperformed a broad index of developed markets, resulting in 1.0 relatively richer valuations. While the economic fundamentals in the country are good, the concentrated stock market is facing 0.5 company specific headwinds in the near term unless crude prices rebound. 0.0 Japan, in response to the deflation threat and persistent Current month 3 months ago 1 year ago 3 years ago currency strength, added another ¥11 trillion to its asset MSCI US MSCI Emerging purchase program in October, following the increase in Equity Index MSCI EAFE Index Markets Index September. While the decision was broadly anticipated, the Bank of Japan also unveiled its unlimited lending program to Sources: MSCI, FactSet, as of 10/31/12. banks in a bid to stoke lending and economic growth. Although the new lending facility parallels the Funding for Lending initiative pioneered by the Bank of England this summer, we remain skeptical of the policy impact. The real challenge faced Figure 5: Valuations and Market Returns–Price/Earnings by Japan, and to some extent the United Kingdom, is not the 24.9 25.5 supply-side shortage, but a lack of demand for capital driven 25 by private sector deleveraging. However, we remain neutral on Japan and the United Kingdom, mainly for their attractive 20 19.4 valuations and portfolio diversification benefits. We are tactically cautious on Singapore, as its valuation looks 15 14.5 14.4 14.6 14.1 a bit rich in light of a slowdown in growth momentum, elevated 12.5 13.1 12.2 inflation pressure and declining margins for banks. That said, 11.5 11.0 in the longer term, we remain constructive on Singapore along 10 with the other CASSH countries (Canada, Australia, Switzerland, Singapore, Hong Kong) for their low public leverage, which we 5 expect to translate into better long-term growth prospects.Emerging Markets: In While global growth is slowing overall, it’s 0accelerating in some emerging markets. After an aggressive round Current month 3 months ago 1 year ago 3 years agoof policy easing in many emerging countries, those efforts havefinally borne fruit with growth starting to take off. We believe that MSCI US MSCI Emerging Equity Index MSCI EAFE Index Markets Indexemerging markets still offer a good opportunity for investorslooking to gain access to growth, given their currently attractive Sources: MSCI, FactSet, as of 10/31/12.valuations. From a regional approach, we prefer Asia and LatinAmerica relative to emerging EMEA. emerging Asia, we like China but are downgrading Taiwan to In further monetary accommodation is limited with an already low neutral. Improving PMIs and export growth point to a stabilization interest rate and worsening inflation. of activity in China. As China embarks on a once-in-a-decade Among the remaining emerging markets, we prefer Russia and leadership transition, the make-up of the new government should Brazil. After central bank-led policies to reduce systemic risk offer greater clarity on the future direction for economic policy. surprised the markets, investors have returned to emerging markets Meanwhile, the downgrade of Taiwan is motivated by valuation and with greater differentiation and focus on country-specific funda- earnings uncertainty in semiconductors. Not only does the price- mentals. In particular, Russia has been undermined by falling energy to-earnings multiple of Taiwan look rich compared to the developed prices and short-term excess supply as global demand fell. We world technology sector, corporate profits, especially for semicon- remain constructive on Russia because of the compelling valuation ductor manufacturers, could face further headwinds from a lower and a sanguine view that crude oil prices will rise due to dwindling utilization rate and associated pricing pressure. Furthermore, a flux spare capacity in OPEC and rising demand in China. of newly implemented tax policies is taking a toll, while room for
INVESTMENT DIRECTIONS [ 6 ]Global SectorsGlobal equity markets finished down in October on the back of September the sector has underperformed the broader market to thea soft earnings season that reflected deteriorating business extent that valuations are again looking compelling.conditions through third quarter, and companies struggling to We remain underweight global consumer discretionary, US retailbeat analysts’ revenue forecasts given the slowdown in the United especially. On the positive side, credit growth in the United States hasStates, recession in Europe and policy uncertainty in China. More picked up and consumer confidence is at a five-year high, thanks to aimportantly, management guidance for fourth quarter was mostly mending housing market, some job creation and robust stock marketnegative, with businesses in the United States cutting capital returns. Valuations, however, are rich, and could come under pressurespending and delaying hiring due to the uncertainty surrounding if upcoming tax hikes and spending cuts occur. With consumer debtthe fiscal cliff. This month we have downgraded US industrials to levels still high and real hourly wage growth dismal, personalneutral and upgraded global technology to overweight, in addition consumption has been largely supported by a decline in the savingsto downgrading European financials to underweight. rate and government transfer payments, including extended unemployment benefits. As we expect heightened market volatility into year-end with loss of We have downgraded European financials to underweight, as market momentum and policy uncertainty, we continue to be defen- valuations after the recent rally appear stretched in light of the still sively positioned within the global equity universe. We prefer profitable soft fundamentals and ongoing pressure on banks to restructure companies with good cash flows and strong balance sheets, such as their operations, cut costs and satisfy more stringent capital rules. global mega caps, and advocate portfolio construction techniques to We maintain our underweight view on global financials, with the help minimize fund volatility for downside protection. expectation that the tougher regulatory environment will persist after While defensive sectors such as consumer staples tend to be less Obama’s re-election. Also, while the Fed’s more accommodative sensitive to economic uncertainty, they currently appear expensive monetary policy has supported loan demand, ultra-low rates hurt and we maintain a benchmark allocation. The exception is US utilities banks’ net interest margins and profitability. where we remain underweight, thanks to a potentially significant While more cautious investor sentiment may weigh on energy stocks multiple compression if the lower dividend tax rates are allowed to in the near term, we maintain our constructive longer term view of the expire at year-end. sector given favorable long-term supply-demand trends and Due to subdued business sentiment, we have downgraded US attractive valuations. Oil prices may find further support from the industrials to neutral, which we have balanced by upgrading global ongoing tensions in the Middle East and a pickup in emerging market technology to overweight. Earnings expectations for technology demand thanks to improving fundamentals, considering the market companies have decreased somewhat, but since the end of is currently relatively tight with limited OPEC spare capacity.Figure 6: Global Sector Near-Term Outlooks and the Factors Behind Them* Global Sector Valuations Profitability Risk/ Our View (P/B) Sentiment underweight neutral overweight Related iShares ETF Tickers Cyclical Sectors Consumer Discretionary – Energy + IXC, FILL, EMEY, AXEN IYF, IXG, AXFN, EMFN, EUFN, Financials + – – FEFN, IAT Industrials IYJ, EXI, AXID Information Technology – + + IXN, AXIT, AAIT, IYW, SOXX IYM, MXI, AXMT, EMMT, RING, Materials + – PICK, SLVP Defensive Sectors Consumer Staples – + IYK, KXI, AXSL Healthcare – + + IYH, IXJ, AXHE Telecommunications – IXP, AXTE, IYZ Utilities** + – IDV, JXI, AXUT – unattractive + attractive neutral current underweight outlook current overweight outlook current neutral outlook previous month (if not shown – same as current)* Please see appendix for an explanation of our factor methodology. ** This chart focuses on global sector views only. For US sector views, please see Figure 2.This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information shouldnot be relied upon by the reader as research, investment advice or a recommendation regarding the iShares Funds or any security in particular. This information is strictly for illustrative andeducational purposes and is subject to change. This information does not represent the actual current, past or future holdings or portfolio of any BlackRock client.
INVESTMENT DIRECTIONS [ 7 ]Fixed Income SectorsAlthough US Treasury yields were more stable this month, they Figure 7: Fixed Income Sector Near-Term Outlooksremain close to historical lows. Meanwhile, the spread betweenthe Barclays High Yield Index and the 10-year Treasury note has Fixed Income Sector Under Neutral Over Related iSharesnarrowed from 608 basis points at the end of May to 525 basis weight weight ETF Tickerspoints today. Investors should also take note of how quickly rates EMB, LEMB,fell: a 50% contraction in the 10-year note yield the last 12 Emerging Markets x CEMB, EMHYmonths, the sharpest drop since records began in 1953. Nor is HYG, HYXU,the collapse in yields unique to the United States. Two-year rates High Yield Credit x GHYG, QLTB,in several European countries are actually negative. Given this QLTCcompression in yield and spreads, we have downgraded high yield LQD, FLOT, QLTA, MONY, ENGN,to underweight for the near term. Investment Grade Credit x AMPS, CSJ, CIU, CFT, CLY, QLTA Wecontinue to advocate the addition of modestly more MBB, GNMA, exposure to spread products. We also believe in reducing Mortgage-Backed Securities x CMBS exposure to duration risk, for which investors are insufficiently Municipals x SUB, MUB compensated. Non-US Developed Markets x ISHG, IGOV We have downgraded high yield to underweight for the near term. The rush into high yield is understandable as yield-hun- STIP, TIP, GTIP, TIPS/Global Inflation-Linked x gry investors have few alternatives. In one sense, tighter ITIP spreads are justified. US corporate balance sheets look SHY, IEI, IEF, US Treasuries x TLH, TLT, GOVT, pristine, with S&P 500 companies sitting on more than $2 SHV trillion in cash and default rates at only around 2%, half of their long-term average. To be sure, further spread tightening This material represents an assessment of the market environment at a specific time and is not is possible if conditions improve in Europe or the fiscal cliff is intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research, investment advice or a recommendation regarding avoided, but the recent rally in fixed income has pushed the iShares Funds or any security in particular. This information is strictly for illustrative and spreads to their lowest level since July 2011. With economic educational purposes and is subject to change. This information does not represent the actual current, past or future holdings or portfolio of any BlackRock client. growth stuck in the 2% vicinity, spreads would typically be closer to 600 basis points over Treasuries, as opposed to the We maintain a longer term underweight view of both US current level of less than 500 basis points. In short, spreads Treasuries and Treasury Inflation Protected Securities (TIPS). now appear tight relative to the economic environment, TIPS continue to have negative real rates, while Treasuries suggesting little upside in the near term. Longer term, we still offer little more than cash in the way of yield. Record-low like high yield as an efficient way to generate potential yield coupons on Treasuries mean that duration risk is at a record with a reasonable amount of volatility. high. However, we are mindful of the significant economic risks US investment grade credit remains more attractive than other posed by the fiscal cliff and therefore remain near-term fixed income alternatives. Spreads versus Treasuries remain neutral on both US Treasuries and TIPS. significantly above their historical average. In addition, while We continue to advocate a benchmark weight to mortgage- investment grade bonds are offering much higher yields than backed securities (MBS), as we believe MBS prices largely Treasuries, the default risk on corporate debt remains low. anticipated the impact of the Fed’s intentions to increase We also favor municipal bonds. Following the presidential purchases of these assets announced in September. Upside is election, volumes in municipal bonds have increased on also limited by prepayment uncertainty resulting from lower buying and spreads have tightened relative to Treasuries as rates and the potential for additional new policy tools to investors price in an increasing likelihood of higher marginal further loosen the refinancing market. We’ll reassess our tax rates on upper income brackets. However, high-grade outlook on this type of debt if we see more significant changes municipals currently offer more attractive yields than US resulting from the latest round of quantitative easing. Treasuries and have relatively modest credit risk. And despite Outside the United States, we favor emerging market bonds. tightening, spread levels continue to appear elevated relative Despite some widening of emerging market spreads since to credit risk, unless you believe another recession is likely to mid-October, spreads have continued to grind tighter over the occur in the United States. Actual credit events in the high- course of the year. Relative to many developed markets, grade municipal space remain rare, despite isolated local emerging market sovereign issuers have favorable debt bankruptcy headlines. burdens and fiscal positions.
INVESTMENT DIRECTIONS [ 8 ]ContributorsRuss Koesterich, CFA, is the Global Chief Investment Strategist for BlackRock’s iShares ETF business. He is a founding memberof the BlackRock Investment Institute, delivering BlackRock’s insights on global investment issues. During his 20+ year careeras an investment researcher and strategist, Mr. Koesterich has served as the Global Head of Investment Strategy for scientificactive equities and as a senior portfolio manager in the US Market Neutral Group at BlackRock. Mr. Koesterich is a frequentcontributor to financial news media and can regularly be seen on CNBC, Fox Business News and Bloomberg TV. He is the authorof two books, including his most recent, The Ten Trillion Dollar Gamble, which details how to position portfolios for the impact ofthe growing U.S. deficit. Mr. Koesterich is also regularly quoted in print media including the Wall Street Journal, USA Today,MSNBC.com, and MarketWatch. He earned a BA degree in history from Brandeis University, a JD from Boston College and anMBA in capital markets from Columbia University.Nelli Oster, PhD, is an Investment Strategist in BlackRock’s iShares business, where her responsibilities include developingtactical country, sector, commodity and asset allocation models implementable with iShares ETFs. Dr. Oster’s service with thefirm dates back to 2008, including her time with Barclays Global Investors (BGI), which merged with BlackRock in 2009. Beforejoining iShares, Dr. Oster did research and portfolio management in BGI’s quantitative stock selection business, spanning US,Canada, Japan and emerging markets portfolios. Prior to joining BGI, Dr. Oster was an equity research analyst at GoldmanSachs, and she started her career in the mergers and acquisitions group of Salomon Smith Barney. Dr. Oster holds a BSc(Hons) in management sciences from the London School of Economics and a PhD in finance from the Stanford GraduateSchool of Business, where her Behavioral Finance dissertation focused on expectations formation and learning in thefinancial markets.Matthew Tucker, CFA, has spent the past 16 years focused on fixed income portfolio management, analytics and strategy.As Head of North American Fixed Income iShares Strategy within BlackRock’s Fixed Income Portfolio Management team,Mr. Tucker leads the investment strategy for fixed income ETFs in North America and Latin America, focusing on productdevelopment, client support, and thought leadership. He previously worked with Barclays Global Investors before it mergedwith BlackRock, and he led the US Fixed Income Investment Solutions team responsible for overseeing product strategy foractive, index, enhanced index, iShares and long/short products. Mr. Tucker was also a portfolio manager and a trader in fixedincome focused on U.S. government securities. He began his career at Barra, where he supported clients using the company’sfixed income analytics. He holds a bachelor of business administration degree from the University of California, Berkeley, andis a Chartered Financial Analyst charterholder.Stephen Laipply is a member of BlackRock’s Model-Based Fixed Income Portfolio Management Group. Mr. Laipply’s servicewith the firm dates back to 2009, including his years with Barclays Global Investors (BGI), which merged with BlackRock in 2009.At BGI, he was a senior investment strategist on the US Fixed Income Investment Solutions team, responsible for developing anddelivering fixed income solutions to clients. Mr. Laipply focuses primarily on the iShares (ETF) fixed income product suite. Prior tojoining BGI, he was a senior member in both the Strategic Solutions and Interest Rate Structuring Groups at Bank of AmericaMerrill Lynch, where he structured and marketed fixed income solutions across interest rates, credit and mortgages to institu-tional investors. Mr. Laipply earned a BS degree, with honors, in finance from Miami University, and an MBA in finance from theUniversity of Pennsylvania. How do you use this market commentary and do you find it useful? Please share your feedback and any questions or concerns you have at questions@iShares.com. You also can find the latest market commentary from the iShares Investment Strategy Group at iSharesblog.com and iShares.com.
INVESTMENT DIRECTIONS [ 9 ]AppendixThe analysis behind our views: Growth prospects: We focus on leading indicators that areOur country and sector views are based on a systematic analysis constructed to predict a country’s future economic growth. Weof the extent to which macroeconomic factors have been priced in assign a “+” to countries that are expected to grow fast relative toat the country and sector level. their own past trends and to other countries, and a “-” to coun- tries that are growing more slowly.In coming up with our country views, we use price-to-book (P/B)ratio as a measure of a country’s value. This ratio captures how the Corporate sector profitability: We focus on return on assets (ROA)market prices a given country relative to the assets it has available and on cross-country comparisons, although we also take intofor production. The higher the ratio, the more favorably the market account developments in a country’s ROA over time. A country withviews the country relative to its own history and to other countries. a highly profitable corporate sector is assigned a “+”; one with low profitability is assigned a “-.”The price the market is willing to pay for the assets of a country ispositively related to its expected future growth and corporate Risk / sentiment: We focus on sovereign credit default swap (CDS)sector profitability, and negatively related to the riskiness of its spreads, which measure investor perception of the likelihood thatassets. We use factors such as leading economic indicators and a given country will default on its obligations. We mainly compareretail sales growth as proxies for expected future growth. We use CDS spreads across countries, although we also take into accountreturn on assets (ROA) as a proxy for future profitability and we use trends in a country’s CDS spreads over time. A country that iscredit default swap (CDS) spreads as a measure of risk and perceived as relatively safe is assigned a “+”; a risky country issentiment. In addition, we consider factors such as commodity assigned a “-.”prices that affect importer and exporter countries in opposite ways. While the valuation, growth, profitability and risk / sentimentIn determining the sensitivity of a country’s valuations to these factor readings are discrete, we use continuous measures in ourmacroeconomic factors, we look at trends both over time and investment process. In addition, the factors are not equallyacross countries. We are overweight (underweight) countries important in driving returns at a given point in time. As a result,where market valuations are low (high) relative to what we would when it comes to formulating our final views, the various factorexpect, with the expectation that the economic factors will be fully readings are not additive. For example, a “+” value factor, indicat-incorporated into prices in the future. We use a similar process for ing that a country looks cheap, may overshadow negative readingscoming up with our sector views. in other factors, leading us to still like the country.Factor table methodology We use a similar methodology in coming up with the readings inHere’s an explanation of the methodology of our country our sector factor table. We focus on a mix of cross-sectional andfactor table: time-series comparisons of valuations (P/B), profitability (ROE) and risk / sentiment (sector spreads). In addition, we consider theValuations: In determining whether a country looks cheap or global growth outlook for cyclical and defensive sectors.expensive, we focus on price-to-book ratio (P/B), both over timeand across countries. If a country has a low P/B relative to both Risk appetite dial methodologyits own trading history and to other countries, we assign it a “+”; if Our global risk appetite dial measures current market sentiment.it has a high P/B, we assign it a “-.” We mainly compare developed It is constructed from equity market returns, corporate creditmarket countries to other developed market countries and spreads and expectations for future economic growth. High equityemerging market countries to other emerging market countries. returns, narrow credit spreads and a good growth outlook tend toWe compare countries that benefit or suffer from their own coincide with positive investor sentiment and stronger appetite forspecific issues, e.g., corporate governance problems in Russia, to risky assets.their own trading histories.GlossaryUnderweight: Potentially decrease allocation Overweight: Potentially increase allocation Neutral: Consider benchmark allocationLong Term: Longer than one year Near Term: 12 months or less