Current Market Conditions & Investor Behavior


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4th quarter guide to the current market and economic environment. Lessons from investor behavior and a historical perspective.

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  • Today I’m going to give you an update on the financial and economic environment through the end the of the third quarter, put that it historical context and discuss a few things that you, as an investor, can do to make smarter decisions and maximize the probability of achieving your long-term financial goals.
  • But first, a word from the lawyers. If you want to ask a question during the presentation, you’ll see a message box in the lower righthand section of the screen – choose the drop down box to send it to me – the presenter, then type your answer and hit send. Time permitting, I’ll try to answer them as they come in.
  • Why listen to me? Well, prior to joining Just Plans, I worked for four leading financial services companies and most recently was a VP of institutional services in charles schwab’s $250 billion investment management division. There, I advised companies offering retirement plans, banks, financial advisors, and other institutional investors on investment strategies for the benefit of their own clients. This past January, I joined Jim Ellman at Just Plans – and we are a fee-only wealth management firm. That is, we serve as our clients personal financial officer – helping them identify and quantify their financial goals, then work with them to design a plan to maximize the probability of achieving those goals. Finally, we take over the day to day management of their financial assets – all while acting as a fiduciary.
  • There’s a lot of information contained on these slides, but we’re going to focus on some key themes and data points. Here on the two charts on the left, you see the YTD performance of the S&P 500 at 3.9% and a return of 11.3% for third quarter. What’s noteworthy is that four times this year, the S&P 500 has dipped into negative territory for the year and four times it has recovered. And whereas we considered much of the volatility of 2008 and 2009 due to deleveraging, we consider this year’s volatility more a function of uncertainty – that is uncertainty among investors.
    Looking at the chart just below it, the S&P has returned a remarkable 74% since it’s low on March 3, 2009. Yet is still 22% off it’s peak on October 9, 2007.
  • This chart is interesting because it shows the value, performance and consensus estimate P/E ratio for the S&P 500 at various peaks and troughs over the last 15 years. What is particularly interesting is that on March 24, 2000 – the S&P had a forward P/E of 25.6 – clearly expensive by historical standards. Subsequently the market crashed and then recovered by October 9, 2007 to that 1,500 level, but only trading at 15x forward P/E – just below the long-term average of 16.6 times. Obviously it crashed from there because many asset values – particularly those around real estate were artificially high and as well the credit worthiness of many consumers and bonds whose debt theirs was packaged into. Subsequently it as rebounded from it’s low on March 9, 2009. Again, with forward EPS expected to be around $80, that could support a level for the S&P 35% higher than it is now (which it would take to reach it’s long-term average valuation). Now that’s not without risks, namely deflation and/or a double dip recession, but we’ll talk more about that in a few slides.
  • The left had side of this chart is interesting because it shows the implied average annual return needed for the S&P 500 to return to its peak reached in 2007. So we could have four strong years of returns with the S&P 500 returning 10.7%/year – just to get back to its peak! This just gives you a sense of the returns required to reach those peak levels again.
    The chart on the right side is interesting because here we see the returns for various bear markets and the subsequent recovery.
  • Last column – 10 year cum return of various asset classes. In ’90s, every time you bought equities on dips, you made money. Not true in ‘00. but in fixed income, just about every time you buy a bond, you make money and it reinforces you to buy more – exactly the opposite of what you should be doing.
  • Here we can see the Fed Funds Target rate currently at 0.25%. The blue line above that shows the yield on the 10 year treasury, currently at about 2.53% - around a historic low. Though inflation may remain low for the time being, a record issuance of treasuries, combined with a rebounding global economy should push yields higher, including those of other high-quality, investment grade, and longer maturity bonds. What’s the implication of that?
  • Impact on a 1% change in interest rates on price of bonds – last two columns.
  • Commodity prices to move up, driven by growth in EM infrastructure demand. In general 5% is considered a prudent allocation. Gold – speculation. Not a use asset, not driven by inflation, but maybe fear. Back in the early ‘80s, gold lost 60% of its value in just a few years and has yet to recover in real terms. Oil peaked at over $130/barrel the summer of 2007 and had you bought back then, you would be out about 40% of your money since then. The point is, even within asset classes, such as commodities, stay diversified.
  • It is clear from the chart on the left that GDP growth is taking place. Why in the US, the consumption is so important to GDP growth – it makes up 70% of it! While it is certainly possible we could certainly see a double dip recession in the US, it is not probable. Here is why . . .
  • Economy growing since Sept ’09 per NBER. No recession has lasted more than 24 months except the great depression. And the average expansion has last 43 months – of which we’re 12 months into it.
  • Recession concentrated in certain sectors: Auto, Residential Construction, business equipment, and inventories. Which makes sense as these are often big ticket items and the first areas consumers and businesses are going to cut back in a recession. They account for only 20% of GDP, but in recessions, historically have accounted for over 100% of the change in GDP. So far, they’ve contributed to 100% of the growth of GDP – which is great, but that the rest of the economy really hasn’t started to kick in yet.
    3% growth in first year of recovery below long term average of 5% over last 7 recoveries.
  • Now let’s talk about employment, on the right side – private payroll only, otherwise distorted by census and other seasonal workers. On the left you can see that unemployment nationally fallen to 9.6%, obviously it’s higher here around California and currently around 12%. Possible 1% per year decline in unemployment. Need 1.5% gdp growth to add payroll jobs, need 2.3% to bring unemployment down. Hence, why unemployment has stalled. Expect slow growth to continue around 3% annualized, but to pick up in 2011.
  • Bottom right, debt service ability improving b/c of refinancing, more personal investment, consumer spending building up and consumer in a better position to borrow and lenders more willing to lend. So a few slides ago, we talked about how cyclical expenditures have picked in the last year and the slide before that we talked about how consumption is the biggest component of GDP at 70%. Here we can see how personal balance sheets are actually improving, which will eventually lead to increased consumption. At top we see personal savings rate increasing to 5.7% and the debt service ratio falling. Again, with investors generally hoarding cash and other short-term low yielding investments, the could result in real lift to companies and GDP. Leading indicators that consumption should be rising.
  • But I want to give you a balanced view and the economy is not without its risks. Obviously, individual and companies have been hit, but so has the government – shelling out $250B in TARP money and another $787B in fiscal stimulus. This year will be a record budget deficit and it cannot be made-up for in GDP growth and tax receipts alone. In the future, the budget gap will have to be narrowed, buy reducing expenditures. Many people believe the Fed will have to raise rates significantly from where there are now, which could cause the Dollar to fall. The reality the other major developed nations are in no better shape that US – The Euro zone, UK, & Japan all have debt to GDP similar to us. Where the dollar is likely to lose ground is to EM nations, that are currently more financially sound that us. Concerns – grid lock after elections, let the bush tax cuts expire fully expire, don’t fix the budget, and the federal debt explodes, there is certainly an increased chance of double dip recession. The point is, the economy’s not without it risks, stay diversified.
  • No let’s look overseas, I talked about the US economy and the rest of the developed world. As you can see on the top chart, for the last 11 years, global growth has exceed that of the US. If you look at the bottom chart, you can see where that is specifically coming from - Emerging economies. Now GDP growth doesn’t always translate into investment opportunities, but certainly it’s a factor. Obviously, international investing is not without its risks. Including, currency risk, political risk, market risk, liquidity risk, and financial statement risk – just to name a few.
  • Little inflation, no wage inflation. Deflation is often associated with a significant drop in GDP – talk about why prolonged deflation is bad, three symptoms – wages need to fall, monetary policy may not work, wait and see mentality; 2 periods – great depression (four year recession with a 27% drop in real GDP and 25% unemployment) and Japan: four differences – larger asset bubble, stronger currency, higher savings rate (which has prevented Japanese consumers from adding to economic growth), slower population growth.
  • This graph documents compounded performance of fixed income and equity asset classes from 1926 to 2009, based upon growth of a dollar. It shows that US equities have offered higher compounded returns than fixed income investments. Within the equity asset classes, small cap stocks have outperformed large cap stocks, resulting in higher returns and greater wealth accumulation.
    Markets throughout the world have a history of rewarding investors for the capital they supply. Their expected returns offer compensation for bearing market or equity risk.
    Now in 1990, Stanford professor Bill Sharpe (among others) won the nobel prize in economics for his work on CAPM – which is a model that basically says investment risk and reward are related. But taken further, what it really says is that risk and expected return are related. That’s a subtle, but important difference. And I think warren buffet said it best when it said “be fearful when others are greedy and greedy when others are fearful.”
  • Now to be successful in investing, you need to understand many things. One of which is your ability to withstand changes in market values – which we refer to ask risk tolerance. And with equity investing, you need to have a long-term perspective. And that is, it is generally accepted that you should have a time horizon of at least five years before investing a significant part of your portfolio in equities.
    This slide illustrates that short-term losses are often embedded in longer-term gains. The graph shows the growth of $1 invested in the S&P 500 Index in 1926 until the present, and details the index’s performance during a single year (1999). The first bubble plots monthly returns and the adjacent bubble shows daily returns for a single month (April 1999). Although the S&P 500 Index delivered a strong 21.04% return in 1999, five of the months had negative returns. The market delivered a 3.9% total return during April, even though it closed with losses on many days.
    Investors who want to capture the higher returns of stocks must accept the possibility of experiencing daily, monthly, and yearly losses along the way. Disciplined investors must focus on the big picture while knowing that short-term volatility will often test their resolve.
  • The recessions during the mid 1970s and early 1980s each lasted 17 months. There was no formal announcement of the 1973-75 recession because the National Bureau of Economic Research (NBER) did not announce business cycles prior to 1979. However, the NBER announced the 1981-82 recession 6 months after it began, and announced the recession’s end 8 months into the next recovery.
    In both recessions, unemployment peaked after the US economy had rebounded. Although the stock market declined early in both down cycles, stocks had begun to recover before the onset of each business upturn.
  • In both the early 1990s and 2000, the recessions lasted nine months each, but were not announced until after they were over. Moreover, the NBER did not announce each recession’s end until almost two years later. Unemployment also peaked in the months prior to the official end.
    In the 1990s recession, the market began its recovery before the end, while the market languished for two years before rebounding after the 2001 downturn. This provides additional evidence that the stock market does not behave predictably through business cycles.
  • This graph documents bull and bear market periods in the S&P 500 Index from January 1, 1926 to March 2010.
    The market cycles are identified in hindsight using historical cumulative daily returns. All observations are performed after the fact. A bear market is identified in hindsight when the market experiences a negative daily return followed by a cumulative loss of at least 10%. The bear market ends at its low point, which is defined as the day of the greatest negative cumulative return before the reversal. A bull market is defined by data points not considered part of a bear market.
    The rising trend lines in blue designate the bull markets occurring since 1926, and the falling trend lines in red document the bear markets. The bars that frame the trend lines help to describe the length and intensity of the gains and losses. The numbers above or below the bars indicate the duration (in calendar days) and cumulative return percentage of the bull or bear market.
    Keep in mind that this graph does not show total compounded returns or growth of wealth since 1926. Once the cycle is established in retrospect, the first day of that cycle resets the performance baseline to zero.
    Investors may draw a number of lessons from this graph. First, since 1926, bull markets in the S&P 500 Index have lasted longer than bear markets and delivered price gains that are disproportionately greater than the bear market losses.
    Second, fluctuating performance within each trend illustrates that volatility and uncertainty occur even within established market cycles: bull markets may have short-term dips, and bear markets may have short-term advances. The immediate trend is not readily apparent to market observers, and in fact, may become clear only in hindsight. This illustrates the difficulty of accurately predicting and timing market cycles.
    Finally, the graph suggests the importance of maintaining a disciplined investment approach that views market events and trends from a long-term perspective. Investors who react emotionally to short-term movements are at risk of making ill-timed decisions that compromise long-term performance.
  • The third slide in this format compares the performance of short-term fixed income instruments to the S&P 500 Index.
    The bars indicate the percentage of the time that S&P 500 Index outperformed one-month T-bills for each rolling period. For example, the S&P 500 Index beat T-bills in 68% of the one-year periods, in 76% of the five-year periods, and in 95% of the fifteen-year periods. Equally revealing, the S&P 500 outperformed Tbills 100# of the time in twenty-, thirty-, and forty-year holding periods.
    Although the S&P 500 Index has outperformed Treasury bills for every twenty-year period since 1926, investors should not conclude that stocks are guaranteed to outperform over every twenty-year period in the future. There is no time period over which investors can be assured of a positive equity premium—that is the nature of risk.
    In summary, long-term success in the capital markets requires a long-term exposure to the risk factors that reward investors with appropriate compensation.
  • This is what happens to volatility over time. Over the last ten years, gold has returned 15.5% a year on average and over the last 20 years, 5.2% year on average and over the last 30 years just 2%/year. No five year period in the last 60 when a 50/50 portfolio last money during a five year period. Per the chart in the upper right corner, 10.8% may not seem that much greater than 6.2%, but it compounds to create over twice the wealth over a 20 year period.
  • This cartogram depicts the world not according to land mass, but by the size of each country’s stock market relative to the world’s total market value (free-float adjusted). As you can see, the US stock market is 42% of the world’s market capitalization. However, the typical US investor has 76% of their equity invested there.
    Population, gross domestic product, exports, and other economic measures may influence where people invest. But the map offers a different way to view the universe of equity investment opportunities. If markets are efficient, global capital will migrate to destinations offering the most attractive risk-adjusted expected returns. Therefore, the relative size and growth of markets may help in assessing the political, economic, and financial forces at work in countries.
    The cartogram brings into sharp relief the investible opportunity of each country relative to the world. It avoids distortions that may be created or implied by attention to economic or fundamental statistics, such as population, consumption, trade balances, or GDP.
    By focusing on an investment metric rather than on economic reports, the chart further reinforces the need for a disciplined, strategic approach to global asset allocation. Of course, the investment world is in motion, and these proportions will change over time as capital flows to markets offering the most attractive returns.
  • Given what we’ve been through, investors have been adopting an increasingly conservative posture. The amount of money held is cash in remarkable – at $2.8 trillion, it’s equal to 90% of the capitalized value of the S&P 500. What is equally remarkable, is this money is earning close to zero. Market is at extremes, stocks to bonds, and here investors are putting money into bonds at extremes. Another measure of conservative behavior is that more money has gone into bond funds in last two years than into equity funds of the last two years of the tech bubble. September marked the 33rd consecutive month more money has gone into bond funds than equity funds.
  • Current Market Conditions & Investor Behavior

    1. 1. Current Market Conditions and Investor Behavior Barry Mendelson, CFP® 925-988-0330 x22 As of September 30, 2010 1
    2. 2. Opinions expressed are those of Barry Mendelson, CFP® and Just Plans Etc. This presentation should not be construed as investment advice. The information contained in this presentation is compiled from sources believed to be reliable. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. The markets can remain irrational longer than you can remain solvent. Disclosures 2
    3. 3. Barry Mendelson, CFP® Investment management and personal finance guru. More than 15 years experience working for leading financial services companies including Charles Schwab, AXA Rosenberg, Neuberger Berman, and Franklin Templeton. Prior to joining Just Plans Etc. in 2010, was a Vice President in Charles Schwab & Co’s $200 billion investment management division. Certified Financial Planner™ certificate holder since 2008. B.A. in Business Economics & Accounting from U.C. Santa Barbara in 1995. Just Plans Etc. Founded in 1982 and based in Walnut Creek, California - Just Plants Etc. is a fee-only wealth management firm and SEC registered investment advisor. Just Plans provides investment management and financial planning services to more than 100 individual, families, and companies. As a fiduciary, the firm puts the interests of the client above all else. About 3
    4. 4. Agenda 4 1. Current Market Environment 2. Current Economic Environment 3. Historical Perspective 4. Lessons for the Future
    5. 5. Agenda 5 1. Current Market Environment
    6. 6. Returns by Style 6 Jan-10 Mar-10 May-10 Jul-10 Sep-10 1,000 1,050 1,100 1,150 1,200 1,250 Source: Russell Investment Group, Standard & Poor’s, FactSet, J.P. Morgan Asset Management. All calculations are cumulative total return, including dividends reinvested for the stated period. Since Market Peak represents period 10/9/07 – 9/30/10 , illustrating market returns since the most recent S&P 500 Index high on 10/9/07. Since Market Low represents period 3/9/09– 9/30/10 , illustrating market returns since the S&P 500 Index low on 3/9/09. Returns are cumulative returns, not annualized. For alltim e periods, total return is based on Russell- style indexes with the exception of the large blend category, which is reflected by the S&P 500 Index. Past performance is not indicative of future returns. Data are as of 9/30/10. Jan-07 Jan-08 Jan-09 Jan-10 600 800 1,000 1,200 1,400 1,600 S&P 500 Index S&P 500 Index 2010: +3.9% 3Q10: +11.3% Since 10/9/07 Peak: -22.0% 3Q 2010 Since Market Low (March 2009) YTD 2010 Since Market Peak (October 2007) Charts reflect index levels (price change only). All returns and annotations reflect total return, including dividends. Since 3/9/09 Low: +74.3% Value Blend Growth Value Blend Growth Large 10.1% 11.3% 13.0% Large 4.5% 3.9% 4.4% Mid 12.1% 13.3% 14.6% Mid 11.1% 11.0% 10.9% Small 9.7% 11.3% 12.8% Small 7.9% 9.1% 10.2% Value Blend Growth Value Blend Growth Large -27.5% -22.0% -14.8% Large 80.8% 74.3% 73.7% Mid -16.1% -14.6% -14.0% Mid 114.1% 106.0% 98.7% Small -17.9% -16.5% -15.5% Small 103.0% 101.3% 99.5%
    7. 7. S&P 500 Index at Inflection Points 7 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 600 800 1,000 1,200 1,400 1,600 Index level 1,527 1,565 1,141 P/E Ratio (fwd) 25.6x 15.2x 12.3x Dividend yield 1.1% 1.8% 2.1% 10-yr. Treasury 6.2% 4.7% 2.5% Source: Standard & Poor’s, First Call,Compustat , FactSet, J.P. Morgan Asset Management. Dividend yield is calculated as the annualized dividend rate divided by price, as provided byCompustat . Forward Price to Earnings Ratio is a bottom- up calculation based on the most recent S&P 500 Index price, divided by consensus estimates for earnings in the next twelve months (NTM), and is provided by FactSet Market Aggregates. Returns are cumulative and based on S&P 500 Index price movement only, and do not include the reinvestment of dividends. Pastpe rformance is not indicative of future results. Data are as of 9/30/10. S&P 500 Index -49% Oct. 9, 2002 P/E (fwd) = 14.1 777 Mar. 24, 2000 P/E (fwd) = 25.6 1,527 Dec. 31, 1996 P/E (fwd) = 16.0 741 Sep. 30, 2010 P/E (fwd) = 12.3 1,141 +101% Oct. 9, 2007 P/E (fwd) = 15.2 1,565 -57% Mar. 9, 2009 P/E (fwd) = 10.3 677 +69% Characteristic Mar-2000 Oct-2007 Sep-2010
    8. 8. Equity Scenarios: Bull, Bear, and In-Between 8 39.7% 19.6% 13.6% 10.7% 9.0% 7.9% 7.1% 6.5% 6.1% 5.7% 1 Yrs 2 Yrs 3 Yrs 4 Yrs 5 Yrs 6 Yrs 7 Yrs 8 Yrs 9 Yrs 10 Yrs 10/9/07 Peak 1,565 Distance Left to Peak 424 S&P 500 Index: Return Needed to Reach 2007 Peak Source: Standard & Poor’s, J.P. Morgan Asset Management. ( Left) Data assume 2.5% annualized dividend yield. Implied values reflect the average geometric total returns required for the S&P 500 to reach its 10/9/07 peak of 1,565 over each stated time period. Chart is for illustrative purposes only. Past performance does not guaran tee future results. ( Right) A bear market is defined as a peak-to- trough decline in the S&P 500 Index (price only) of 20% or more. The bull run data reflectthe market expansion from the bear market low to the subsequent market peak. All returns are S&P 500 Index returns, and do not include dividends. *Current bull run from 3/9/09 through 9/30/10. Implied avg. annualized total return Implied cumulative total returnX% Analysis as ofSep. 30, 2010. Index has risen68.7% since low of 677. X% 39.7% 43.1% 64.6% 50.3% 54.0% 57.9% 61.8% 65.9% 70.0% 74.3% Recovery So Far 464 Decline Peak to Trough 888 9/30/10 Level 1,141 3/9/09 Trough 677 Bear Market Cycles vs. Subsequent Bull Runs Market Peak Market Low Bear Market Return Length of Decline Bull Run Length of Run Yrs to Reach Old Peak 5/29/46 5/19/47 -28.6% 12 257.6% 122 3.1 yrs 7/15/57 10/22/57 -20.7% 3 86.4% 50 0.9 yrs 12/12/61 6/26/62 -28.0% 6 79.8% 44 1.2 yrs 2/9/66 10/7/66 -22.2% 8 48.0% 26 0.6 yrs 11/29/68 5/26/70 -36.1% 18 74.2% 31 1.8 yrs 1/5/73 10/3/74 -48.4% 21 125.6% 74 5.8 yrs 11/28/80 8/12/82 -27.1% 20 228.8% 60 0.2 yrs 8/25/87 12/4/87 -33.5% 3 582.1% 148 1.6 yrs 3/24/00 10/9/02 -49.1% 31 101.5% 60 4.6 yrs 10/9/07 3/9/09 -56.8% 17 68.7%* - - Average: -35.0% 14 mo's 176.0% 68 mo's 2.2 yrs
    9. 9. Various Asset Class Returns 9 10-yrs 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 3Q10 YTD '00 - '09 Real Estate Real Estate DJ UBS Cmdty MSCI EME Real Estate MSCI EME Real Estate MSCI EME Barclays Agg MSCI EME MSCI EME Real Estate Real Estate 26.4% 13.9% 23.9% 56.3% 31.6% 34.5% 35.1% 39.8% 5.2% 79.0% 18.2% 19.1% 174.5% DJ UBS Cmdty Market Neutral Barclays Agg Russell 2000 MSCI EME DJ UBS Cmdty MSCI EME MSCI EAFE Market Neutral MSCI EAFE MSCI EAFE MSCI EME MSCI EME 24.2% 9.3% 10.3% 47.3% 26.0% 17.6% 32.6% 11.6% 1.1%* 32.5% 16.5% 11.0% 162.0% Market Neutral Barclays Agg Market Neutral MSCI EAFE MSCI EAFE MSCI EAFE MSCI EAFE DJ UBS Cmdty Asset Alloc. Real Estate Real Estate Russell 2000 Market Neutral 15.0% 8.4% 7.4% 39.2% 20.7% 14.0% 26.9% 11.1% -23.8% 28.0% 12.8% 9.1% 108.7%. Barclays Agg Russell 2000 Real Estate Real Estate Russell 2000 Real Estate Russell 2000 Market Neutral Russell 2000 Russell 2000 DJ UBS Cmdty Barclays Agg Barclays Agg 11.6% 2.5% 3.8% 37.1% 18.3% 12.2% 18.4% 9.3% -33.8% 27.2% 11.6% 7.9% 84.8% Asset Alloc. MSCI EME Asset Alloc. S&P 500 Asset Alloc. Asset Alloc. S&P 500 Asset Alloc. DJ UBS Cmdty S&P 500 S&P 500 Asset Alloc. Asset Alloc. 0.6% -2.4% -5.4% 28.7% 12.5% 8.0% 15.8% 7.3% -36.6% 26.5% 11.3% 6.0% 60.8% Russell 2000 Asset Alloc. MSCI EME Asset Alloc. S&P 500 Market Neutral Asset Alloc. Barclays Agg S&P 500 Asset Alloc. Russell 2000 S&P 500 DJ UBS Cmdty -3.0% -3.4% -6.0% 25.2% 10.9% 6.1% 14.9% 7.0% -37.0% 22.5% 11.3% 3.9% 50.9% S&P 500 S&P 500 MSCI EAFE DJ UBS Cmdty DJ UBS Cmdty S&P 500 Market Neutral S&P 500 Real Estate DJ UBS Cmdty Asset Alloc. MSCI EAFE Russell 2000 -9.1% -11.9% -15.7% 22.7% 7.6% 4.9% 11.2% 5.5% -37.7% 18.7% 9.3% 1.5% 41.3% MSCI EAFE MSCI EAFE Russell 2000 Market Neutral Market Neutral Russell 2000 Barclays Agg Russell 2000 MSCI EAFE Barclays Agg Barclays Agg DJ UBS Cmdty MSCI EAFE -14.0% -21.2% -20.5% 7.1% 6.5% 4.6% 4.3% -1.6% -43.1% 5.9% 2.5% 0.8% 17.0% MSCI EME DJ UBS Cmdty S&P 500 Barclays Agg Barclays Agg Barclays Agg DJ UBS Cmdty Real Estate MSCI EME Market Neutral Market Neutral Market Neutral S&P 500 -30.6% -22.3% -22.1% 4.1% 4.3% 2.4% -2.7% -15.7% -53.2% 4.1% 0.1% -0.6% -9.1% Asset Source: Russell, MSCI Inc., Dow Jones, Standard and Poor’s, Barclays Capital, NAREIT, J.P. Morgan Asset Management. The “Asset Allocation” portfolio assumes the following weights: 25% in the S&P 500, 10% in the Russell 2000, 15% in the MSCIEAFE, 5% in the MSCI EMI, 30% in the Barclays Capital Aggregate, 5% in the CS/Tremont Equity Market Neutral Index, 5% in the DJ UBS Commodity Index and 5% in the NAREIT Equity REIT Index. Balanced portfolio assumes annual rebalancing. All data except commodities represent total return for stated period. Past performance is not indicative of future returns. Please see disclosure page at end for index defi nitions. Data are as of 9/30/10 , except for the CS/Tremont Equity Market Neutral Index, which reflects data through8/31/10. “10- yrs” returns represent cumulative total return and are not annualized. These returns reflect the period from 1/1/00– 12/31/09. *Market Neutral returns include estimates found in disclosures. Data are as of 9/30/10.
    10. 10. The Federal Reserve '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 0 2 4 6 8 10 12 Fed Funds Target Rate and 10-Year Treasury Yields Source: Federal Reserve, FactSet, J.P. Morgan Asset Management. Data are as of 9/30/10. Grey bars represent Fed tightening cycles Fed Funds Target: 0.0% to 0.25% 10-year Treasuries: 2.53% 10
    11. 11. Fixed Income Yields, Returns, & Risks 11 U.S. Treasuries # of issues Mkt. Value 12/31/2009 9/30/2010 2009 3Q 2010 +1% -1% 2-Year 1.14% 0.42% 1.29% 0.60% -1.99% 0.83%* 5-Year 2.69 1.27 -1.35 3.31 -4.83 4.83 10-Year 3.85 2.53 -9.76 4.53 -8.63 8.63 30-Year 4.63 3.69 -25.88 4.71 -17.72 17.77 Sector Broad Market 8,249 $15,404 bn 3.68% 2.56% 5.93% 2.48% -4.67% 4.67% MBS 1,313 5,010 4.15 3.26 5.89 0.63 -2.94 2.92 Corporates 3,517 2,885 4.73 3.63 18.68 4.71 -6.72 6.72 Municipals 46,123 1,279 3.62 3.01 12.91 3.40 -8.08 8.08 Emerging Debt 338 524 6.59 5.27 34.23 8.14 -6.77 6.77 High Yield 1,747 882 9.06 7.80 58.21 6.71 -4.18 4.18 Yield Return Impact on Price from 1% Change in Rates Source: U.S. Treasury, Barclay’s Capital, FactSet, J.P. Morgan Asset Management. Fixed income sectors shown above are provided by Barclay’s Capital and are represented by- Broad Market: US Barclay’s Capital Index; MBS: Fixed Rate MBS Index; Corporate: U.S. Corporates ; Municipals: Muni Bond Index; Emerging Debt: Emerging Markets Index; High Yield: Corporate High Yield Index. Treasury securitie s data for # of issues and market value based on U.S. Treasury benchmarks from Barclay’s Capital. Yield and return information based on Bellweth ers for Treasury securities. Change in bond price is calculated using both duration and convexity according to the following formula: New Price = (Price + (Price *- Duration * Change in Interest Rates))+(0.5 * Price * Convexity * (Change in Interest Rates)^2) *Calculation assumes 2- Year Treasury interest rate falls 0.42% to 0.00% as interest rates can only fall to 0.00%. Chart is for illustrative purposes only. Data are as of 9/30/10. # of issues: 129 Total value: $3.711 tn
    12. 12. Global Commodities 12 '70 '75 '80 '85 '90 '95 '00 '05 '10 $0 $200 $400 $600 $800 $1,000 $1,200 $1,400 '70 '75 '80 '85 '90 '95 '00 '05 '10 $0 $20 $40 $60 $80 $100 $120 $140 $160 -3% -2% -1% 0% 1% 2% 3% 4% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: BLS, U.S . Department of Energy, FactSet, J.P. Morgan Asset Management. Data reflect most recently available as of9/30/10. Source: IMF, Bloomberg, J.P. Morgan Asset Management . Industrial metals are represented by copper and aluminum consumption. Data are as of 9/30/10. World Oil Consumption Growth Industrial Metals ConsumptionGrowth -6% -4% -2% 0% 2% 4% 6% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 EM ex. China China DM ex. US U.S. EM ex. China China DM ex. US U.S. Gold Prices- Nominal and Inflation Adjusted WTI Oil Prices- Nominal and Inflation Adjusted 9/30/10: $79.97 9/30/10: $1,307.00
    13. 13. Agenda 13 2. Current Economic Environment
    14. 14. Economic Growth & Composition of GDP 14 -$2,000 $0 $2,000 $4,000 $6,000 $8,000 $10,000 $12,000 $14,000 $16,000 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 -8% -6% -4% -2% 0% 2% 4% 6% 8% 10% Source: BEA, J.P. Morgan Asset Management. Data reflect most recently available as of9/30/10 . GDP values shown in legend are % change vs. prior quarter annualized and reflect revised2Q10 GDP. Real GDP % chg at annual rate 20- yr avg. Latest Real GDP: 2.5% 1.7% Components of GDP 10.2% Investment ex-housing 70.6% Consumption 20.5% Gov’t Spending Billions, USD 2.5% Housing / Construction - 3.7% Net Exports
    15. 15. Economic Expansions and Recessions 15 0 25 50 75 100 125 1900 1912 1921 1933 1949 1961 1980 2001 - 26.7% -1.7% -2.6% -3.7% -1.6% -0.6% -3.2% -2.2% -2.9% -1.4% - 0.3% -4.1% 0 yrs 1 yrs 2 yrs 3 yrs 4 yrs 5 yrs 1910 1930 1950 1970 1990 2010 The Great Depression and Post War Recessions Length and severity of recession Great Depression: 26.7% decline in real GDP Most Recent Recession: 4.1% decline in real GDP Source: NBER, BEA, J.P. Morgan Asset Management. Bubble size reflects the severity of the recession, which is calculated as the decline in real GDP from the peak quarter to the trough quarter except in the case of the Great Depression, where it is calculated from the peak year (1929) to the trough year (1933), due to a lack of available quarterly data. Data are as of9/30/10. Source: NBER, J.P. Morgan Asset Management. *Chart assumes current expansion continued through September 2010. Data for length of economic expansions and recessions obtained from the National Bureau of Economic Research (NBER). This data can be found at and reflects information throughSeptember2010. For illustrative purposes only. Length of Economic Expansions and Recessions Average Length (months): Expansions: 43 months Recessions: 15 months *
    16. 16. Contributors to GDP Growth 16 conomy Source: BEA, NBER, J.P. Morgan Asset Management. Last 50 Years are from 2Q60– 2Q10. Last 7 Recessions are measured from peak real GDP to trough real GDP. Last 7 Recoveries are defined as the four quarters fo llo wing the NBER- designated trough quarter. Most Recent Recession is defined from peak real GDP in4Q07 to trough real GDP in 2Q09. Note that contribution numbers are approximations due to the use of chain- weighted GDP, which is not designed to sum exactly. Most recent data as of 9/30/10. Percent Share Percent Share Percent Share Percent Share Percent Share Overall GDP Growth 3.2 100.0% -1.8 100.0% 5.0 100.0% -4.1 100.0% 3.0 100.0% Less Cyclical Components 2.6 81.2% 0.7 -39.9% 2.0 40.1% 0.6 -15.5% -0.0 -0.8% Consumption Ex-Autos 2.1 66.6% 0.1 -4.0% 2.4 47.9% -1.0 23.4% 1.1 35.6% Commercial Construction 0.1 1.9% -0.1 3.8% -0.1 -2.3% -0.6 14.6% -0.4 -14.8% Net Exports -0.1 -2.5% 0.4 -23.8% -0.6 -12.7% 1.5 -37.4% -0.8 -26.1% Government 0.5 15.2% 0.3 -15.9% 0.4 7.2% 0.7 -16.1% 0.1 4.4% More Cyclical Components 0.6 18.8% -2.5 139.9% 3.0 59.9% -4.8 115.5% 3.0 100.8% Auto Consumption 0.1 3.1% -0.2 11.4% 0.4 7.7% -0.6 15.2% 0.1 3.3% Residential Construction 0.1 2.2% -0.5 27.3% 0.7 14.5% -1.3 32.4% 0.1 4.4% Equipment 0.4 12.9% -0.3 15.7% 0.5 9.1% -1.6 38.0% 1.1 36.1% Change in Inventories 0.0 0.6% -1.5 85.5% 1.4 28.6% -1.2 29.9% 1.7 57.0% Current Recovery (1st Yr) Last 50 Years Last 7 Recessions Last 7 Recoveries (1st Yr) Most Recent Recession
    17. 17. Employment 17 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 -1,000 -800 -600 -400 -200 0 200 400 600 '60 '70 '80 '90 '00 '10 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% Source: BLS, J.P. Morgan Asset Management. Data reflect most recently available as of9/30/10. Civilian Unemployment Rate Employment - Total Private Payroll 50-yr. avg.: 6.0% Source: BLS, J.P. Morgan Asset Management. Data reflect most recently available as of9/30/10. Seasonally adjusted Total job gain/loss (thousands) Jan. 2009: -806K Aug. 2010: 67K Aug. 2010: 9.6%
    18. 18. Consumer Finances 18 10% 11% 12% 13% 14% 15% '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 $0 $10 $20 $30 $40 $50 $60 $70 Personal Savings Rate '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 0% 2% 4% 6% 8% 10% 12% Annual, % of disposable income Consumer Balance Sheet Trillions of dollars outstanding, not seasonally adjusted Source: (Left) FRB, J.P. Morgan Asset Management. Data includes households and nonprofit organizations. (Right) BEA, FRB, J.P. Morgan Asset Management. Household Debt Service Ratio Debt payments as % of disposable personal income, seasonally adjusted Total Assets: $67 tn Total Liabilities: $14 tn Homes: 26% Deposits: 11% Pension funds: 17% Other financial assets: 36% Other tangible: 10% Mortgages: 73% Revolving (e.g.: credit cards): 6% Non-revolving: 11% Other Liabilities: 10% YTD 2010: 5.7% 1Q80: 11.2% 3Q10*: 11.9% 3Q07: 14.0% Personal savings rate is calculated as personal savings (after- tax income– personal outlays) divided by after-tax income. Employer and employee contributions to retirement funds are included in after- tax income but not in personal outlays, and thus are implicitly includedin personal savings. Savings rate data are as ofAugust 2010. *3Q10 Household Debt Service Ratio is J.P. Morgan Asset Management estimate. Allother data are as of 2Q10.
    19. 19. Federal Finances 19 0% 25% 50% 75% 100% 125% 1940 1950 1960 1970 1980 1990 2000 2010 2020 -35% -25% -15% -5% 5% 1940 1950 1960 1970 1980 1990 2000 2010 2020 % of GDP, 1940– 2020* Federal Debt (Accumulated Deficits) % of GDP, 1940– 2020* Source: U.S. Treasury,BEA, CBO, OMB , J.P. Morgan Asset Management. 2010 numbers reflect CBO estimates for FY 2010. Other numbers are based on the Administration’s proposed 2011 budget from the OMB. Note : Years shown are fiscal years (Oct. 1 through Sep. 30). Bottom left chart displays federal debt in the hands of the public . Data reflect most recently available as of 9/30/10. Federal Budget Surplus/Deficit *Administration’s proposed 2011 budget Total Projected 2010 Budget Receipts: $2,143 billion Total Projected 2010 Budget Outlays: $3,485 billion Projected Surplus / Deficit: - $1,342 billion Source: CBO, J.P. Morgan Asset Management. U.S. Proposed Federal Budget Outlays - 2010 *Administration’s proposed 2011 budget Other 12% Entitlements: Social Security Medicare Medicaid 43% Defense (Discretionary) 20% Non- Defense (Discretionary) 19% Net Interest 6%
    20. 20. The economic growth differential 20 Source: J.P. Morgan Global Economics Research, IMF, J.P. Morgan Asset Management. Data are as of July 2010 and are provided by the International Monetary Fund. 2010 and 2011 data are estimates as provided by the IMF. Emerging and Developed Economy GDP growth rates represent quarterly annualized growthestimated by J.P. Morgan Global Economics Research and are as of 2Q10. Data are as of 9/30/10. U.S. GDP Growth World GDP Growth Difference World GDP Growth vs. U.S. GDP Growth Emerging and Developed GDP Growth Emerging Economies Developed Economies -3% 0% 3% 6% 9% 1970 1975 1980 1985 1990 1995 2000 2005 2010 -9% -2% 5% 12% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
    21. 21. Consumer Price Index 21 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 -3% 0% 3% 6% 9% 12% 15% Source: BLS, J.P. Morgan Asset Management. Data reflect most recently available as of9/30/10 . CPI values shown are % change vs. 1 year ago and reflectAugust 2010 CPI data. CPI component weights are as of Dec. 2009 and 12- month change reflects data throughAugust 2010. Core CPI is defined as CPI excluding food and energy prices. CPI and Core CPI 50- yr. Avg. Latest Headline CPI: 4.0% 1.2% Core CPI: 4.0% 1.0% % chg vs. prior year CPI Components Weight in CPI 12-month Change Food & Bev. 14.8% 1.0% Housing 42.0% -0.2% Apparel 3.7% -0.3% Transportation 16.7% 4.8% Medical Care 6.5% 3.2% Recreation 6.4% -1.1% Educ. & Comm. 6.4% 1.9% Other 3.5% 3.0% Headline CPI 100.0% 1.2% Less: Energy 8.6% 3.8% Food 13.7% 1.0% Core CPI 77.7% 1.0%
    22. 22. Agenda 22 3. Historical Perspective
    23. 23. Monthly: January 1926-December 2009 CRSP data provided by the Center for Research in Security Prices, University of Chicago. The S&P data are provided by Standard & Poor's Index Services Group. US long-term bonds, bills, inflation, and fixed income factor data © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield). $8,201 Small Cap (CRSP 6-10 Index) $2,590 Large Cap (S&P 500 Index) $85 Long-Term Government Bonds Index $20 Treasury Bills $12 Inflation (CPI) $10,000 $1,000 $100 $10 $1 $0 1926 1936 1946 1956 1966 1976 1986 1996 2006 2009 Growth of Wealth 23
    24. 24. S&P 500 $2,048 January 1926–December 2009 The S&P data are provided by Standard & Poor's Index Services Group. Indexes are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Not to be construed as investment advice. April 1999 Daily Returns Total Month of April Return: 3.9% During this month, the S&P 500 had 10 days of negative returns out of 21 trading days. 1999 Monthly Returns Total Annual Return: 21% During this year, the S&P 500 had 5 out of 12 months with negative returns. • Even during periods of positive stock returns, investors may experience substantial volatility. • Short-term volatility is a typical characteristic of stock market investing. • Long-term returns are the sum of short-term volatility. J F M A M J J A S O N D 1 15 30 -2.24% -0.49% -3.11% -2.36% -3.12% -2.74% 21.04% Stocks vs. the Risk-Free Rate 24
    25. 25. Prior to 1979, there were no formal announcements of business cycle turning points. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio. For illustrative purposes only. Past performance is not a guarantee of future results and there is always the risk that an investor will lose money. Source: National Bureau of Economic Research (NBER) for economic expansions and recessions data; the S&P data are provided by Standard & Poor’s Index Services Group; US Bureau of Labor Statistics for unemployment data. Recession Begins November 1973 Recession Ends March 1975 Unemployment Peaks at 9.0% May 1975 Recession 17 months Recession Begins July 1981 Recession Announced January 6, 1982 Unemployment Peaks at 10.8% Nov/Dec 1982 Recession 17 months Recession Ends November 1982 Recession End Announced July 8, 1983 Mid 1970s and Early 1980s Recessionary Periods 25
    26. 26. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio. For illustrative purposes only. Past performance is not a guarantee of future results and there is always the risk that an investor will lose money. Source: National Bureau of Economic Research (NBER) for economic expansions and recessions data; the S&P data are provided by Standard & Poor’s Index Services Group; US Bureau of Labor Statistics for unemployment data. Recession Begins July 1990 Recession Announced April 25, 1991 Unemployment Peaks at 7.8% June 1992 Recession 9 months Recession Ends March 1991 Recession End Announced December 22, 1992 Recession Begins March 2001 Recession Ends November 2001 Unemployment Peaks at 6.3% June 2003 Recession 9 months Recession Announced November 26, 2001 Recession End Announced July 17, 2003 Early 1990s and Early 2000s Recessionary Periods 26
    27. 27. S&P 500 Index (USD) Daily Returns: January 1, 1926-March 31, 2010 Indices are not available for direct investment; its performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results. The S&P data are provided by CRSP (January 1, 1926-August 31, 2008) and Bloomberg (September 1, 2008-March 31, 2010). Returns include reinvested dividends. Bull and bear markets are defined in hindsight using cumulative daily returns. A bear market (1) begins with a negative daily return, (2) must achieve a cumulative return less than or equal to -10%, and (3) ends at the most negative cumulative return prior to achieving a positive cumulative return. All data points which are not considered part of a bear market are designated as a bull market. Performance data represents past performance and does not predict future performance. 220% -13% -85% 20% -16% -39% 119% 88% 27% -15% -10% -13% 100% 44% -53% 25% 40% -13% -14% 26% -25% 22% -11% 23% -33% 83% -11% 99% -26% 19% -11% -16% 26% 53% 91% -13% 121% -11% 26% -13% 18% 69% -21% -11% 44% -27% 15% 96% -11% 59% -27% -10% -21% -32% 56% -12% 38% -45% 22% -13% 50% -13% 38% -15% 27% -13% 26% -10% 21% -16% 48% -20% 78% -11% 156% -33% 73% -10% 16% -19% 303% -11% 37% 50% -19% -12% 23% -11% 13% -47% 21% -14% 113% -55% 03/09/2009 -55% 3/31/2010 -20%1% 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Average Duration Bull Market: 413 Days Bear Market: 220 Days Average Return Bull Market: 58% Bear Market: -21% Bull and Bear Markets 27
    28. 28. 75% 76% 84% 95% 100% 100% 100% 68% The S&P data are provided by Standard & Poor’s Index Services Group. One-Month Treasury Bills © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield). Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Values change frequently and past performance may not be repeated. There is always the risk that an investor may lose money. Even a long-term investment approach cannot guarantee a profit. Economic, political, and issuer-specific events will cause the value of securities, and the portfolios that own them, to rise or fall. Because the value of your investment in a portfolio will fluctuate, there is a risk that you will lose money. Indexes are referred to for comparative purposes only and do not represent similar asset classes in terms of components or risk exposure; thus, their returns may vary significantly. The S&P 500 Index measures the performance of large cap US stocks. One-Month T-Bills measure the performance of US government-issued Treasury bills. Percentage of All Rolling Periods Where S&P 500 Index Outperformed One-Month T-Bills Rolling Time Periods 1 Year 3 Years 5 Years 10 Years 15 Years 20 Years 30 Years 40 Years Total Number of Periods 997 973 949 889 829 769 649 529 Number of Periods S&P 500 Index Outperformed One-Month T-Bills 674 731 723 751 785 769 649 529 Monthly: January 1926-December 2009 Large Stocks vs. Fixed Income 28
    29. 29. Historical returns by holding period 29 -37% -8% -15% 0.1% -2% -2% 1% 1% -1% 1% 2% 0.5% 6% 1% 5% 0.3% 51% 43% 32% 14% 28% 23% 21% 11% 19% 16% 17% 9% 18% 12% 14% 7% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% 60% 1-yr. 5-yr. rolling 10-yr. rolling 20-yr. rolling Annual total returns, 1950-2009* Range of Stock, Bond, Blended and Cash Total Returns Asset Sources: Factset, Robert Shiller, Strategas/Ibbotson, Federal Reserve, J.P. Morgan Asset Management. *The 20-yr. cash (T-Bill) returns were calculated using 20 year annualized returns from 1953 – 2009. Data are as of 9/30/10. 50/50 Portfolio 9.0% $560,441 Bonds 6.2% $333,035 Stocks 10.8% $777,670 Annual Avg. Total Return 50/50 Portfolio Bonds Stocks Cash (T-Bills) Cash (T-Bills) 2.1% $151,536 Growth of $100,000 over 20 years
    30. 30. $28.6 Trillion as of December 31, 2009 In US dollars. Map reflects countries in the MSCI All Country World IMI Index and MSCI Frontier Markets Index. Market cap data is free-float adjusted. MSCI data copyright MSCI 2009, all rights reserved. Vietnam data provided by MFMI. Many small nations not displayed. Totals may not equal 100% due to rounding. For educational purposes; should not be construed as investment advice. 1. An example large cap stock provided for comparison. MSCI Index Affiliation  Developed Markets  Frontier Markets  Emerging Markets SCALE Ten Billion One Trillion World Market Capitalization 30
    31. 31. Mutual fund flows 31 -$60 -$40 -$20 $0 $20 Aug '07 Feb '08 Aug '08 Feb '09 Aug '09 Feb '10 Aug '10 Source: Investment Company Institute, J.P. Morgan Asset Management. Data include flows throughAugust 2010 and exclude ETFs. ICI data are subject to periodic revisions. International equity flows are inclusive of emerging market, global equity and regional equity flows.Hybrid flows include asset allocation, balanced fund, flexible portfolio and mixed income flows. Data are as of 9/30/10. Difference between net flows into stock and bond fundsNet fund flows (monthly) Billions, USD, U.S. and international fundsBillions, USD, U.S. and international funds Equity flows Fixed income flows Bond flows exceeded equity flows by $47 billion in Aug ’10 Fund Flows Billions, USD AUM YTD 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 Domestic Equity 3,471 (45) (39) (151) (48) 11 31 111 130 (25) 54 260 176 World Equity 1,242 27 31 (82) 139 148 105 67 23 (3) (22) 50 11 Taxable Bond 2,067 188 307 20 98 45 26 3 39 124 76 (36) 8 Tax-exempt Bond 513 28 69 8 11 15 5 (14) (7) 16 12 (14) (12) Hybrid 653 12 23 (19) 24 7 25 43 32 8 10 (31) (14) Money Market 2,827 (496) (539) 637 654 245 62 (157) (263) (46) 375 159 194 -$60 -$40 -$20 $0 $20 $40 $60 Aug '07 Feb '08 Aug '08 Feb '09 Aug '09 Feb '10 Aug '10
    32. 32. Agenda 32 4. Lessons for the Future
    33. 33. Lessons for the future 33 1. Define your goals 2. Create a plan 3. Put it into action 4. Stay on track
    34. 34. Barry Mendelson, CFP® 925-988-0330 ext. 22 1399 Ygnacio Valley Rd, Suite 24 Walnut Creek, CA 94598 Contact info 34
    35. 35. Index Definitions 35 All indexes are unmanagedandan individualcannotinvest directly inan index. Index returns do not include feesor expenses. The S&P 500 Index is widelyregarded asthe best single gauge of theU.S.equities market.Thisworld-renowned index includes a representative sample of 500 leadingcompaniesin leading industriesof theU.S.economy. Although the S&P 500 Index focuseson the large-cap segment of themarket,with approximately75% coverage of U.S. equities,it is alsoan ideal proxyfor the total market.An investor cannotinvest directly in an index. The S&P 400 Mid CapIndexis representative of 400 stocksin the mid-range sector of the domestic stock market, representing all major industries. The Russell 3000Index® measuresthe performanceof the 3,000 largest U.S. companiesbasedon total market capitalization. The Russell 1000Index ® measures theperformance of the 1,000 largestcompaniesin the Russell 3000. The Russell 1000GrowthIndex ® measures theperformance of thoseRussell 1000companieswith higher price-to-book ratiosand higher forecasted growth values. The Russell 1000Value Index ® measures the performance ofthose Russell 1000 companieswith lowerprice- to-book ratios and lower forecasted growth values. The Russell MidcapIndex ® measures the performance ofthe 800 smallest companiesin the Russell 1000 Index. The Russell MidcapGrowthIndex ® measures the performance ofthose Russell Midcap companies with higher price-to-book ratiosand higher forecasted growth values.The stocks are also membersof the Russell 1000 Growth index. The Russell MidcapValue Index® measuresthe performanceof those Russell Midcap companies with lower price-to-book ratiosand lower forecasted growth values. The stocksare also members of the Russell 1000 Value index. The Russell 2000Index ® measures theperformance of the 2,000 smallestcompaniesin the Russell 3000 Index. The Russell 2000GrowthIndex ® measures theperformance of thoseRussell 2000companieswith higher price-to-book ratiosand higher forecasted growth values. The Russell 2000Value Index ® measures the performance ofthose Russell 2000 companieswith lowerprice- to-book ratios and lower forecasted growth values. The MSCI® EAFE (Europe, Australia, Far East) NetIndexis recognized asthe pre-eminentbenchmark in the United States tomeasure international equity performance. Itcomprises21 MSCI countryindexes, representing the developed marketsoutside of North America. The MSCI EmergingMarkets IndexSM isa free float-adjusted marketcapitalization indexthatis designed to measure equity market performance in the global emerging markets. Asof June 2007, the MSCIEmerging Markets Index consisted of the following 25 emerging marketcountryindices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan,Korea, Malaysia,Mexico, Morocco, Pakistan, Peru,Philippines, Poland, Russia,South Africa,Taiwan,Thailand, and Turkey. The MSCI ACWI(AllCountry WorldIndex)Index is a freefloat-adjustedmarket capitalization weighted index that is designed to measurethe equitymarketperformanceof developed and emerging markets. Asof June 2009 the MSCI ACWI consisted of 45 countryindices comprising 23 developed and 22 emerging marketcountryindices. The MSCI SmallCapIndicesSM target 40% ofthe eligible Small Cap universe within each industry group, within each country.MSCI definesthe Small Cap universeas all listedsecurities that have a market capitalization in the range of USD200-1,500 million. The MSCI Value andGrowthIndicesSM cover the full rangeof developed,emerging and All Country MSCIEquity indexes. As of the closeof May30, 2003,MSCI implementedan enhanced methodology forthe MSCI Global Value and Growth Indices, adopting a two dimensional frameworkfor style segmentation in which value and growth securitiesare categorized using differentattributes - three for value and five forgrowth including forward- looking variables.The objective of theindex design is to divide constituentsof an underlying MSCIStandard Country Indexinto a value indexand a growth index, each targeting 50% ofthe free float adjusted market capitalization ofthe underlying country index. Country Value/Growth indices are then aggregated intoregional Value/Growth indices.Prior to May 30,2003, theindicesusedPrice/BookValue (P/BV) ratiosto divide the standard MSCIcountryindicesinto value and growth indices. All securitieswere classified as either "value" securities (lowP/BV securities) or "growth" securities(high P/BV securities),relative to each MSCI country index. The following MSCITotalReturnIndicesSM are calculated with grossdividends: This series approximatesthe maximumpossible dividend reinvestment. The amount reinvestedis the dividend distributed to individualsresident in the countryof thecompany, butdoes notinclude tax credits. The MSCI Europe IndexSM is a free float-adjusted marketcapitalizationindex that is designed tomeasure developed marketequityperformancein Europe. Asof June 2007, the MSCIEurope Indexconsisted of the following 16 developed marketcountryindices:Austria,Belgium,Denmark,Finland,France,Germany, Greece, Ireland, Italy,the Netherlands, Norway,Portugal, Spain,Sweden, Switzerlandand the United Kingdom. The MSCI Pacific IndexSM is a free float-adjusted market capitalization indexthat isdesigned to measureequity market performance in the Pacificregion.As of June 2007, the MSCI PacificIndexconsisted of the following5 Developed Market countries:Australia,HongKong, Japan,NewZealand, and Singapore.
    36. 36. Index Definitions 36 MunicipalBondIndex:To be included in the index, bondsmustbe rated investment-grade (Baa3/BBB- or higher) by at least two of the following ratingsagencies: Moody's, S&P,Fitch.If onlytwo ofthe threeagencies rate the security,the lowerrating is used to determine indexeligibility. Ifonly one of the three agenciesrates a security,the rating must be investment-grade. They musthavean outstanding par value ofat least$7 million and be issued as part of a transaction of at least $75 million. Thebonds mustbe fixed rate,have a dated-date after December 31, 1990, and must be at leastone year from their maturity date. Remarketed issues,taxable municipal bonds,bonds with floating rates, and derivativesare excluded fromthe benchmark. The Barclays CapitalEmergingMarkets Index includesUSD-denominated debtfromemerging markets in the following regions: Americas, Europe, Middle East, Africa,and Asia.As with other fixed income benchmarks provided by Barclays Capital,the indexis rules-based,which allowsfor an unbiased view ofthe marketplace and easy replicability. The Barclays CapitalCorporateBondIndex is the Corporate componentof the U.S. Creditindex. The Barclays CapitalTIPSIndex consists of Inflation-Protection securitiesissued by theU.S.Treasury. The NAREITEQUITY REIT Index is designed to provide the most comprehensive assessmentof overall industry performance,and includes all tax-qualified real estate investment trusts (REITs) thatare listedon the NYSE,the American StockExchange or the NASDAQ National MarketList. The J.P. MorganEMBI GlobalIndex includesU.S. dollar denominated Bradybonds, Eurobonds, traded loans and local market debt instrumentsissued by sovereign and quasi-sovereign entities. The J.P. MorganDomestic HighYieldIndex is designedto mirrorthe investable universe of the U.S.dollar domestic high yieldcorporate debtmarket. The CS/Tremont Equity Market NeutralIndextakes both long and shortpositionsin stocks with theaim of minimizing exposure tothe systematicriskof themarket (i.e.,a beta of zero). The CS/Tremont Multi-StrategyIndex consists of fundsthat allocate capital based on perceived opportunities among several hedge fund strategies. Strategiesadoptedin a multi-strategyfund may include,but are not limited to, convertiblebond arbitrage, equitylong/short, statistical arbitrage and merger arbitrage. *Market Neutral returnsfor November2008 are estimatesby J.P. Morgan FundsMarketStrategy, and are based on a December 8, 2008 published estimate forNovember returns byCS/Tremont in which the Market Neutral returns were estimated to be +0.85% (with 69% of all CS/Tremontconstituentshavingreported returndata). Presumed to be excluded fromthe November returnare three funds,which were later marked to $0 by CS/Tremontin connection with the Bernard Madoff scandal. J.P.Morgan Fundsbelievesthis distortion isnot an accurate representationof returns in the category.CS/Tremont later published a finalized November return of - 40.56% for the month,reflecting thismark-down.CS/Tremontassumesno responsibility for these estimates. All indexes are unmanagedandan individualcannotinvest directly inan index. Index returns do not include feesor expenses. Credit Suisse/Tremont Hedge FundIndexis compiled byCreditSuisse Tremont Index,LLC.It is an asset- weighted hedge fund indexand includesonlyfunds, asopposed to separateaccounts.The Index usesthe Credit Suisse/Tremontdatabase, which tracksover 4500 funds, and consistsonlyof fundswith a minimum of US$50 million under management, a 12-month track record,and audited financial statements. Itis calculated and rebalanced on a monthly basis, and shown netof all performance fees and expenses. Itis the exclusive property of Credit Suisse Tremont Index,LLC. The NCREIFProperty Index isa quarterlytime seriescomposite total rate of return measure of investment performance of a very large pool ofindividual commercial real estate propertiesacquired in the private market for investmentpurposesonly.All propertiesin the NPIhavebeen acquired, atleastin part, on behalfof tax-exempt institutional investors- the great majority being pension funds. As such, all propertiesare held in a fiduciary environment. The Dow Jones-UBS Commodity Index is composedof futurescontractson physical commoditiesand represents nineteen separate commoditiestraded on U.S. exchanges, with the exception ofaluminum,nickel, and zinc. The Barclays CapitalU.S.Aggregate Index representssecurities that are SEC-registered,taxable, and dollar denominated. Theindex covers theU.S.investment grade fixed rate bond market, with indexcomponentsfor government and corporate securities, mortgage pass-throughsecurities,and asset-backedsecurities.These major sectors are subdivided into more specific indexesthatare calculated and reported on a regular basis. This U.S. Treasury Index isa componentof the U.S. Governmentindex. West Texas Intermediate (WTI) isthe underlying commodity for the NewYorkMerchantile Exchange'soil futures contracts. The Barclays CapitalHighYieldIndex coversthe universe of fixed rate,non-investmentgrade debt. Pay-in-kind (PIK) bonds, Eurobonds,and debt issuesfromcountriesdesignated as emerging markets(e.g., Argentina, Brazil, Venezuela, etc.) are excluded, but Canadianand global bonds(SEC registered) of issuers in non-EMG countries are included. Original issuezeroes,step-up coupon structures,and 144-Asare also included.
    37. 37. Additional Risks & Disclosures 37 Derivatives may be riskier than other types of investments because they may be more sensitive to changes in economic or market conditions than other types of investments and could result in losses that significantly exceed the original investment. The use of derivatives may not be successful, resulting in investment losses, and the cost of such strategies may reduce investment returns. There is no guarantee that the use oflong and short positions will succeed in limiting an investor's exposure to domestic stock market movements, capitalization, sector swings or other risk factors. Investing using involving long and short selling strategies may have higher portfolio turnover rates.Short selling involves certain risks, including additional costs associated with covering short positions and a possibility of unlimited loss on certain short sale positions. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation. NOT FDIC INSURED - NO BANK GUARANTEE - MAY LOSE VALUE Past performance is no guarantee of comparable future results. Diversification does not guarantee investment returns and does not eliminate the risk of loss. Bonds are subject to interest rate risks. Bond prices generally fall when interest rates rise. The price of equity securities may rise, or fall because of changes in the broad market or changes in a company’s financial condition, sometimes rapidly or unpredictably. These price movements may result from factors affecting individual companies, sectors or industries, or the securities market as a whole, such as changes in economic or political conditions. Equity securities are subject to “stock market risk” meaning that stock prices in general may decline over short or extended periods of time. Small- capitalization investing typically carries more risk than investing in well- established "blue- chip" companies since smaller companies generally have a higher risk of failure. Historically, smaller companies' stock has experienced a greater degree of market volatility than the average stock. Mid- capitalization investing typically carries more risk than investing in well- established "blue- chip" companies. Historically, mid- cap companies' stock has experienced a greater degree of market volatility than the average stock. Real estate investments may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector. Real estate investments may be subject to risks including, but not limited to, declines in the value of real estate, risks related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by borrower. International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns. Also, some overseas markets may not be as politically and economically stable as the United States and other nations. Investments in emerging markets can be more volatile. As mentioned above, the normal risks of investing in foreign countries are heightened when investing in emerging markets. In addition, the small size of securities markets and the low trading volume may lead to a lack of liquidity, which leads to increased volatility. Also, emerging markets may not provide adequate legal protection for private or foreign investment or private property. Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity- linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity- linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.