Outlook

January 19, 2010

We start the new year with pockets of global economic strength — for example, new orders at U.S. industrial companies in December outpaced even the famed BRIC (Brazil, Russia, India and China) countries, while strength in China has led the Chinese government to increase the required reserves held by its banks in an attempt to moderate growth. Developed markets outside the United States, particularly Europe and Japan, have shown more disappointing economic progress. European consumer spending seems to be taking a mid-winter holiday, and Japanese officials have restarted quantitative easing to combat deflationary forces.

Political leaders globally seem to be struggling to develop economic growth plans as a sequel to the broadly successful financial stabilization efforts. This challenge should force the Obama administration more toward the center politically, as a message of job creation and deficit reduction will be needed for the mid-term elections. European leaders are struggling with the varied fiscal woes of their member countries, as exemplified by the challenges surrounding Greece’s debt problem. The recently elected Democratic Party of Japan, out of power for virtually the entire last 60 years, is trying to restart economic growth after that economy has now experienced six consecutive quarters of contraction in nominal economic growth.

Significant market appreciation in 2009 left some assets fairly valued and still offering good return potential, while others have a reduced return outlook. We are most interested in those assets that will generate solid returns or offer protection of principal in our base case scenario, which is measured global growth with accommodative central bank policies. But we are also keen to include assets that we feel will perform acceptably in our primary risk case scenario — that of the Federal Reserve and other central banks tightening policy prematurely.

U.S. Equity

• Strengthening economic data out of the United States has halted the fall of the dollar
• A stabilizing dollar facilitates the Fed’s “low for long” interest rate strategy

EAFE and Emerging Markets

• European retail sales suffer from unemployment and “post-stimulus” hangover
• Strength in Chinese economic activity leads to tightening measures

Fixed Income

• Investment-grade debt is increasingly reliant on traditional credit and technical factors
• The gradual expiration of the Fed’s special liquidity measures is a constructive step toward normalized credit markets

High Yield

• Favorable technical factors are a key support to high-yield bonds
• Issuer refinancing requirements should be met by new cash flows

Global Real Estate

• A 3.5% return in December capped a 41% full year return for global real estate investment trusts (REITs)
• U.S. REITs led in the fourth quarter, while Asia was the top performer for the year

Hedge Funds

• Hedge funds ended 2009 up 20%
• Short bias strategies were alone in the negative return column

Commodities

• Booming Chinese imports reflect metals-intensive infrastructure build
• Rising oil prices are bringing out incremental production

Conclusion
Our expectations for 2010 encompass a base case scenario that envisions continued improvement in global growth accompanied by relatively easy monetary policy. We expect emerging markets to continue to lead the recovery, followed by the United States, Europe and then Japan. We view the most likely risk to this somewhat benign scenario as being premature tightening by central banks that threatens the recovery.