Download - Solving for 2012
-
7/31/2019 Solving for 2012
1/51
solving
for 2012
Market Insights and Outlooks from Senior Investors at Neuberger Berman
-
7/31/2019 Solving for 2012
2/51
Neuberger BermanWe are an independent, employee-controlled investment managerin service to our clients. We partner with institutions, advisors and
individuals throughout the world to customize solutions that address
their needs or income, growth and capital preservation. With more
than 1,700 proessionals ocused exclusively on asset management,
we are deeply grounded in original, undamental research and oeran investment culture o independent thinking. Founded in 1939,
Neuberger Berman today provides solutions across equities, fxed
income and alternative investments.
-
7/31/2019 Solving for 2012
3/51Solving or 20
The past year has been nothing i not unpredictable or investors. Even the most ardent
bears would have been unlikely to anticipate many o the unolding events that caused
markets to gyrate, sometimes spectacularly; meanwhile, many bulls were probably
caught o-guard by the continued earnings health o blue and near-blue chip com-
panies and the pockets o return strength that emerged in the ace o turbulence and
aura o global crisis.
How then, can one seek to opine on the outlook or 2012? To begin with, one needs
a dose o humility. Dicult as it once was to anticipate the ebb and fow o the capital
markets, the task has become harder as countries have traded closer together, econo-
mies have intertwined and the array o investment strategies has escalated. Investment
conclusions must emerge rom disciplined researchyou cant be a ortune teller, but
you can certainly assess conditions analytically and determine what you think may
happen and what may work rom an investment perspective.
At Neuberger Berman, we have been actively observing and investing in the markets
or more than 70 years, with a mission o working with clients to achieve their unique
investment objectives. Rather than impose a house view on our portolio managers,
we provide them with resources and let them make the decisions. It is an approach
that has seen great success over time. This leads to another guideline on investment
outlooks: respect divergent views and understand, to paraphrase Roy Neuberger, our
ounder, that there is more than one way to skin a cat.
With these ideas in mind, I present to you Solving for 2012, with opinions on the
upcoming year rom some o Neuberger Bermans most seasoned investors, and
covering a range o topics including global equities, ed income, alternatives and
multi-asset strategies. Whether investing on your own behal, or working to address
other individual or institutional needs, I believe you will nd this material to be useul
in considering investment positioning and strategy in this turbulent time.
A Look Ahead, With Humility
Sincerely,
Joseph V. Amato
President and Chie Investment Ocer
Neuberger Berman
-
7/31/2019 Solving for 2012
4/51
Contents Introduction lJoseph V. Amato, President and Chie Investment Ocer ....................................... iSraegi Perspeives
Old Dogmas, New Dharmas lAlan H. Dorsey, CFA, Head o Investment Strategy and Risk;Juliana Hadas, CFA, Vice President ........................................................................................4
Multi-Asset Class Portolios lWai Lee, PhD, Chie Investment Ocer andDirector o Research Quantitative Investment Group ................................................................7
Asset Allocation View lNeuberger Berman Asset Allocation Committee .................................10
Gba Equiies
Overview lJoseph V. Amato, President and Chie Investment Ocer.........................................14
U.S. Equities lLeah Modigliani, Multi-Asset Class Strategist ....................................................15
2012 Election lMatthew L. Rubin, Director o Investment Strategy...........................................19
International lBenjamin Segal, CFA, Portolio Manager and Head o Global Equity Team ...............20
Emerging Markets lConrad A. Saldanha, CFA, Portolio Manager Global Equity Team...............22
Greater China lFrank Yao, Senior Portolio Manager Greater China Equity Team.......................24
Gba Fie Ie
Overview l Brad Tank, Chie Investment Ocer Fied Income ...............................................28
U.S. Economy, Rates and Sectors
lAndrew A. Johnson, Chie Investment Ocer
Investment Grade Fied Income ..........................................................................................29
High Yield Bonds and Bank Loans l Ann H. Benjamin, Chie Investment Ocer Leveraged Asset Management ...........................................................................................31
Municipal Bonds l James L. Iselin, Head o Municipal Fied Income .........................................32
Eurozone and Asia Fied Income, Global Currency l Ugo Lancioni, Portolio Manager Global Fied Income and Currency; Thanos Bardas, PhD, Portolio Manager and Global Head o
Sovereigns and Interest Rates.............................................................................................33
Emerging Market Debt l Bobby T. Pornrojnangkool, PhD, Portolio Manager Emerging Market Debt .....................................................................................................34
Aeraives
Private Equity l Anthony D. Tutrone, Global Head o Alternatives.............................................38
Fund o Hedge Funds l Eric Weinstein, Chie Investment Ocer Fund o Hedge Funds.......................................................................................................43
About the Authors l...................................................................................................48
-
7/31/2019 Solving for 2012
5/51
STRATEGIC PERSPECTIVES
-
7/31/2019 Solving for 2012
6/51
-
7/31/2019 Solving for 2012
7/51Solving or 20
A long-term view is complemented by
a combination o shorter-term views
rom systematic models and medium-
term views rom a multidisciplinary
asset allocation committee. This meldsthe concepts o strategic and tactical
asset allocation in a responsive and
adaptive approach. (For eample, see
the display, which depicts a strategic
asset allocation that is comprised o
risk-weighted asset classes and is
dynamic, changing over time depend-
ing on the volatility and correlations o
the underlying asset classes.) The
alternativerebalancing to a static
strategic benchmarkis not unlike
rebalancing to an arbitrary asset
allocation. A risk-balanced approach
can also be employed in single
asset-class mandates. In equities, or
eample, lower-beta managers who
are likely to hold more cash and ed
income and ocus on more deensive
sectors would get higher allocations
than their higher-beta peers. In credit,
the portolio manager may toggle
between credit risk and duration risk
in dierent market environments.
lIquIdITy and TaIl rIsk
managemenT
In addition to seeking overall volatil-
ity reduction, investors are particu-
larly attuned to mitigating the risko etreme tail events, in terms o
both asset class returns and liquid-
ity. Options and swaps are one way
to manage tail risks; however, they
can be costly, particularly in todays
high-volatility environment. Alterna-
tive ways to achieve tail risk mitiga-
tion include epanding or contracting
liquidity based on rich or cheap risk
premia, and allocating assets to man-
agers who can hold cash and vary itsamount dynamically based on market
conditions. Long-only equity strate-
gies with the feibility to hold cash
and ed income instruments when
the manager deems prudent have
the potential to achieve results similar
to other strategies that seek uncon-
strained global-equity eposure, such
as long/short hedge unds, but with
lower ees, higher liquidity and less
tail risk than hedge unds that may
use shorting and leverage. Dierent
hedge und strategies have dierent
sensitivity to equity illiquidity shocks,
however. Strategies such as equity
long/short, convertible arbitrage and
event-driven have historically seenreturn deterioration during times o
illiquidity shocks in the equity
markets. On the other hand, strate-
gies such as statistical arbitrage and
macro have seen little to no return
deterioration, and CTA (commodity
trading advisor) strategies have actu-
ally seen their returns improve in such
environments. Incorporating the latter
in the portolio can help mitigate tail
and illiquidity risk.
InFlaTIonary Hedge
With sovereign debt levels grow-
ing across the globe and signicant
resistance to scal austerity coming
rom both politicians and the general
populace, concern occurs about
uture infation. While commodities
and infation-linked bonds oer a
degree o hedging against infation
and currency depreciation, a risk is
that their beta-to-infation can turn
negative when infation reaches
certain levels, and that perormance
o the asset classes will likely begin to
diverge as signicant changes emerge
in infation estimates. An equal
duration-risked multi-asset portolio
can account or this by adjusting its
monthly sensitivity to infation. This
approach to risk allocates to vari-
ous assets in such a way that each
contributes similarly to the sensitivityo the overall portolio to changes
in infation. The strategy is feible in
that it can adjust to changing betas to
infation and changing orecasts or
infation. Numerous asset classes can
be included, such as high yield bonds,
infation-linked bonds, commodities,
leveraged loans, real estate invest-
ment trusts (REITs), and high-dividend
ExAmPlE: RISk-BAlAncEd StR AtEGIc ASSEt AllocAtIon
Percentage o Sample Allocation Over Time
Source: Neuberger Berman. For illustrative purposes only. The percentages reect the dynamic asset class/indexallocations o a hypothetical risk parity portolio, rebalanced monthly. The inormation shown is hypothetical and isnot representative o any investment product. Indexes are unmanaged and are not available or direct investment.Investing entails risks, including possible loss o principal.
0
10
20
30
40
50
60
70
80
90
100%
EM Equity
EAFE
R2000
R1000
TIPS
Global Agg
U.S. Agg
201120072003199919951991
STRATEGIC PERSPECTIVES
-
7/31/2019 Solving for 2012
8/51Neuberger Berman
equities in sectors such as materials
and energy.
lIaBIlITy rIsk managemenT
Generally, lower interest rates havecaused liabilities to rise, while risk asset
prices have allen. This has led to a
decrease in many pension plans
unded status. Plans that are consider-
ing removing liability hedges are
considering whether now is the time
to do so. One tactic is to make this
decision in the contet o a liability-
driven investing (LDI) ramework.
While basic LDI strategies typically
ocus on investment-grade edincome or liability matching, more
advanced strategies also incorporate
high yield bonds and high-dividend-
paying stocks, such as utilities and
REITs. This LDI++ approach consid-
ers both liability hedging and return
generation, and seeks to add value
through sector research, issue selec-
tion and duration management,while controlling risk.
ouTsourced alTernaTIves
Investors are increasingly seeking
non-discretionary help in their hedge
und and private equity und selec-
tion, due diligence and portolio
construction. The rationale is based
in wanting to create completion
portolios o underlying managers
that are complementary to eitherdirect und commitments that the
investor has made or broad und o
unds commitments that have been
done. In other cases, unds o unds
can be employed to provide non-
discretionary assistance. Although
limited in scope, such implementation
can be a cost-eective solution or
certain large investors who are look-ing or skills to complement their own
internal investment processes.
We hope we have provided insights
into approaches that could prove useul
in seeking to solve or issues that may
concern our readers. And as our 16th
President posited about his own situa-
tion, Determine that the thing can and
shall be done, and then [together] we
shall nd the way.2
2. Abraham Lincolns speech in the House o Representatives (June 20, 1848).
This material is provided or inormational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold asecurity. Investing entails risks, including possible loss o principal. Investments in hedge unds and private equity are speculative and involve a higher degree o risk than moretraditional investments. Investments in hedge unds and private equity are intended or sophisticated investors only. Indexes are unmanaged and are not available or directinvestment. Past perormance is no guarantee o uture results.
Please see disclosures at the end o this publication, which are an important part o this article.
-
7/31/2019 Solving for 2012
9/51
-
7/31/2019 Solving for 2012
10/51Neuberger Berman
assumptions about risk are all being
reevaluated. Risk parity, or eample,
has moved into the spotlight. And
while some o the buzz around this
approach to asset allocation is likelyjust that, we do believe it serves an
important role in certain portolios.
So, where will the dust settle in 2012
and how should investors think about
asset allocation?
Although it is common to dene asset
allocation in strict terms o strategic
and tactical (with time horizons
such as three to ve years or strate-
gic, or signicantly less than this or
tactical), we believe this one-size-ts-all approach actually ts very ew
investors objectives successully. For
instance, the process o rebalancing a
portolio periodically back to
a strategic 60/40 mi may require
trading more requently than a three-
to ve-year investment horizon. How
this process is designed and whetherthese trades should be considered
tactical are up or debate. We think it
is more useul or investors to consider
the degree o uncertainty associated
with their particular time horizons, and
to adjust their investment approach
and diversiy accordingly.
To be sure, diversication is one o
the most basic terms in investing, but
its meaning and application are not
always clear. Based on our etensiveresearch, we believe that investors
should diversiy to the degree they
are uncertain about something.
In other words, i you had perect
orecasting ability, there would be no
need to diversiy at allyou could
simply invest in the assets that would
do well and avoid the others. On theother hand, where you do not have
perect orecasting ability or you
have conditionssuch as etended
time horizonsthat make you less
certain about your epectations, then
it makes sense to adopt an approach
that does not rely so heavily on these
orecasts as inputs.
In the contet o asset allocation, this
is what we believe separates tactical
rom strategic asset allocation deci-sions and is a guide that we believe
investors should consider utilizing
more etensively. Although there is
FInAncIAl cRISIS ShockEd coRRElAtIonS
Roll ing Two-Year Correlation o Stock Market and Currency Returns Within a Given Region
Source: Bloomberg, Neuberger Berman Quantitative Investment Group.
2011
-100
-80
-60
-40
-20
0
20
40
60
80
100%
Switzerland
Canada
Australia
U.K.
Europe
LTCMGlobal
Financial Crisis
Japan
U.S.
2010200820062004200220001998199619941992199019881986
-
7/31/2019 Solving for 2012
11/51Solving or 20
a high degree o uncertainty in
orecasting ar into the uture,
our research has shown that, over
longer investment horizons, risk-
adjusted rewards o risky assets aremore comparable to one another
than they are in the shorter term.
Given that insight, we believe a
portolio constructed using a risk-
balanced approachor one that
selects assets based on their epected
contribution to the portolios risk,
rather than one that is constructed
based on return orecastsmay be
more robust over time. Moreover,
i investors are able to rela certainguidelines, such as those around the
use o leverage, a leveraged risk par-
ity portolio with equal contributions
to risk rom all assets may be able to
generate returns on par with tradi-
tional 60/40 type portolios, but at a
lower volatility and with less tail risk.
With the compounding eect in the
investors avor, lower risk over time
could mean higher returns. Given
the uncertainties we ace going into
2012, such an approach may make
even more sense to consider.
For similar reasons, we believe that
shorter-term tactical asset allocation
also remains essential to achieving
investment success. Such an approach
actors in shorter-term return ore-
casts, including analysis o market
trends and interrelationships among
asset prices. In the period since the
nancial crisis o the late 2000s, we
have witnessed some o the most
dramatic shits in these relationshipsin over a decade. For eample, both
within and across asset categories
including stocks, bonds and curren-
cies, correlations are at historically
etreme levels. Our research has
shown that, increasingly, investor risk
appetitewhether in a risk on or
a risk o periodis driving these
correlations. As such, we believe the
success o a shorter-term asset alloca-
tion approach is determined in part
by the ability to assess, and eectively
manage, these interrelationships.
lookIng aHead
Putting it all together and looking
ahead to 2012, we believe that
investors will remain highly ocused
on asset allocation. Whether one
believes that it accounts or a small
or large part o long-term portolio
return, in our view asset allocation
should not be dictated by passive,
possibly antiquated, assumptions.Factors ranging rom the time
horizon, to both short-term and
long-term asset price and market
behavior, to, o course, the investors
own ability to assess and manage
all o these dynamics will be impor-
tant considerations or multi-asset
class allocation in 2012 and beyond.
This material is provided or inormational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold asecurity. Investing entails risks, including possible loss o principal. Indexes are unmanaged and are not available or direct investment. Past perormance is no guaranteeo uture results.
Please see disclosures at the end o this publication, which are an important part o this article.
STRATEGIC PERSPECTIVES
-
7/31/2019 Solving for 2012
12/510 Neuberger Berman
Asset Allocation View:Positioning Portfolios for the Coming Yearnb B at ati citt
basis to consider the outlooks or a
range o asset classes. For 2012, we
generally avor equities, although
we see a number o potential value
opportunities in ed income andother areas as well. Below, we
present some o our key viewpoints.
Within equiies, the committee
avors U.S. large capitalization stocks
over small-cap, developed interna-
tional and emerging market equi-
ties, due to what we consider solid
earnings growth, attractive valuations
and abundant liquidity. Given the
epectation or continued market
turbulence, we are also avoringincome-oriented securities such as
high-dividend-paying equities, which
tend to dampen portolio volatility in
times o economic distress.
Among fe ie securities, we
preer credit sectors (like corporate
bonds) relative to government issues.
However, we see strong valuation
opportunities or asset-backed and
commercial mortgage-backed securi-
ties ollowing epanding spreads this
past summer.
The committee has an overweight
viewpoint on U.S. ig yie fe
ie securities, based on what we
believe to be attractive valuations
rom both a spread and yield per-
spective. While European debt-market
worries are infuencing high yield
prices, we believe the deault rate or
U.S. high yield bond issuers should
remain low, thanks to robust corpo-
rate balance sheets and cash fows.
Even in the ace o a more signicanteconomic slowdown, stronger cash
fows at companies should ade-
quately cover coupon payments.
In the aeraive asse asses,
the committee avors an overweight
to lower volatility and macro hedge
unds, while noting potential long-
term opportunities in commodities.
volaTIlITy presenTs
opporTunITIes
hege us may be unique in
todays landscape in that both their
short- and long-term prospects maybenet rom, rather than be disrupted
by, macro-related volatility. In the
class o macro-driven unds, the
epected backdrop o market turmoil
actually creates opportunities in both
directional and geographic bets
among global equities, bonds,
currencies and commodities. Lower-
volatility hedge unds may be an
attractive option in volatile markets
or their low correlation to equityand credit beta.
ciies are an area or which
the short-term outlook could di-
er signicantly rom longer-term
prospects. The perormance o most
commodities is tied to the strength
o the global economy. Considering
the wide anticipation o a moderate
pullback in economic growth in both
Asset allocation is a crucial part o the investment process that has become ever more relevant as inves-tors have sought to limit risk in volatile markets, in part by exploring new approaches to diversication
and broadening asset class exposures. At Neuberger Berman, our Asset Allocation Committee is a group
o senior strategists and portolio managers rom across investment disciplines who meet on a regular
-
7/31/2019 Solving for 2012
13/51Solving or 201
emerging and developed economies,
this should mean lower demand
growth or commodities, at least in
the short term. Additionally, develop-
ing economies are ghting againstdomestic infation, which could cut
into commodity demand as well. Over
the longer term, however, a broader
pullback in economic growth would
likely tame some o that infation and
allow policymakers to ease up on the
brakeswhich could, in turn, provide
a boost to commodity perormance.
conclusIonIn summary, the committee holds
a relatively avorable view on the
prospects or equities relative to other
asset classes, based largely on the
sound undamental condition and
reasonable market valuations o many
companies. Overall, the investment
environment will likely continue to be
aected by ongoing risk relating tothe global economy, sovereign debt
and geopolitics, reinorcing the merits
o broadly diversied portolios.
mARkEt VIEwS BASEd on 1-YEAR REtURn oUtlook FoR EAch ASSEt clASS
This material is provided or inormational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold asecurity. Investing entails risks, including possible loss o principal. Indexes are unmanaged and are not available or direct investment. Past perormance is no guarantee outure results. The views expressed herein are generally those o Neuberger Bermans Asset Allocation Committee which comprises nine proessionals across multiple disciplinesincluding equity and fxed income strategists and portolio managers. The Asset Allocation Committee reviews and sets long-term asset allocation models, establishes preerrednear-term tactical asset class allocations and, upon request, reviews asset allocations or large diversifed mandates and makes client-specifc asset allocation recommendations.The views and recommendations o the Asset Allocation Committee may not reect the views o the frm as a whole, and Neuberger Berman advisors and portolio managers mayrecommend or take contrary positions to the views and recommendation o the Asset Allocation Committee. The Asset Allocation Committee views do not constitute a predictionor projection o uture events or uture market behavior. Due to a variety o actors, actual events or market behavior may dier signifcantly rom any views expressed. This mate-rial may include estimates, outlooks, projections and other orward-looking statements. Due to a variety o actors, actual events may dier signifcantly rom those presented.
Please see disclosures at the end o this publication, which are an important part o this article.
ASSET CLASS Below-Normal Return Outlook
Long-Term (10-Yr.+)
Annual Return Outlook Above-Normal Return Outlook
Fixed Income
Investment Grade Fixed Income
U.S. TIPS
High Yield Corporates
Developed International Fixed Income
Emerging Market Fixed Income
Equity
U.S. All Cap Core
U.S. Large Cap
U.S. Small Cap
Master Limited Partnerships
Developed International Equities
Emerging Market EquitiesPublic Real Estate
Real and Alternative Assets
Commodities
Lower Volatility Hedge Funds
Macro Hedge Funds
Private Equity
STRATEGIC PERSPECTIVES
-
7/31/2019 Solving for 2012
14/51
GLOBAL EQUITIES
-
7/31/2019 Solving for 2012
15/514 Neuberger Berman
Overview: Beneath the Surface,Opportunities AwaitJh v. at, pit chi Itt of
the Japan earthquake, the U.S.
Treasury downgrade or the ongo-
ing drama in Europe, these actors
coalesced to heighten market turbu-
lence and reinorce the notion that
markets are truly interconnected as
never beore.
Looking ahead to 2012, we see little
sign that such issues are abating.
European nations, despite ongo-
ing dialogue, continue to struggle
to achieve a credible solution to the
debt crisis. The region, in our opinion,
requires concrete steps toward scal
consolidation ollowed by meaningul
intervention by the European CentralBank. The political process has been
taking much longer than markets de-
mand. While this is understandable,
given the compleities o the political
process, nancial markets may yet
orce the political leadership to move
more quickly.
In the U.S., Congress has postponed
hard decisions about budget cuts un-
til ater the November elections. This
will likely result in important policy
initiatives going into suspended
animation. The world is also watch-
ing closely as to whether China can
successully achieve a sot landing or
its infuential economy. In short, it
seems like heightened volatility, tight
correlations and near-term ocus on
high-level investment choicessuch
as asset class, region and sector
will continue to predominate in the
short term.
Despite this, as evident in our outlookpieces on the U.S., Europe, Emerg-
ing and China equities, we believe
there are eceptional opportunities
or bottom-up investors. For eample,
i you look past the general gloom
in Europe, you nd that there are
numerous high-quality companies
domiciled there with broad global
eposure that are providing strong
earnings at reasonable multiples.
Elsewhere, despite a dicult 2011,
emerging markets continue toprovide secular advantages over
developed counterparts. Economic
growth is much aster, governments
and individuals carry less debt, and
demographics are avorable, as
young and growing populations raise
their living standards and increase
consumption. Among stocks, the
sell-o o 2011 has provided ample
opportunities or bargain hunters.
As or the U.S., individual companies
are actually doing better than the
sluggish economy would suggest.
Many continue to generate healthy
earnings and boast cash-rich bal-
ance sheets, low nancing costs
and limited wage pressures. Overall,
Over the past year, the most commonly used words in relation to the markets were probably macro,volatilityand contagion. The least uttered? Id say fundamentals, as in what dierentiates individual
companies at any given time. Clearly, the big picture was ront and center in 2011, as investors grap-
pled with an array o unanticipated, signicant events oten simultaneously. Whether the Arab Spring,
-
7/31/2019 Solving for 2012
16/51Solving or 201
they seem well-positioned to ride
out a downturn and perorm well
should the economy maintain modest
growth (our epectation) or surprise
on the upside.
In all likelihood, 2012 is going to be
another eventul year. But i, like us,
you think o current volatility and
pessimism as opening and not just
shutting doors, then you may also
see this as a good time to capitalize
on the attractive opportunities thatawait, especially given that many
stocks have seen lower valuations in
the wake o undierentiated market
turbulence. In our view, the key in this
environment is to eert patience and
maintain investment discipline, while
waiting out the structural, big-picture
issues that continue to heighten ani-ety around the world.
This material is presented solely or inormational purposes and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or holda security. Any views or opinions expressed may not reect those o the frm as a whole. Third-party economic or market estimates discussed herein may or may not be realizedand no opinion or representation is being given regarding such estimates. This material may include estimates, outlooks, projections and other orward-looking statements.Due to a variety o actors, actual events may dier signifcantly rom those presented. Investing entails risks, including possible loss o principal. Past perormance is noguarantee o uture results.
Please see disclosures at the end o this publication, which are an important part o this article.
GLOBAL EQUITIES
Uncertainty abounds as we enter
2012or equities and ed income,
in the U.S. and globally. It could be
another trying year. We epect a
barrage o macro issues, including
questions about the ongoing Euro-
pean sovereign debt crisis, whetherChina can avoid a hard landing, the
health o the U.S. economy and the
November elections, to continue to
shape investor sentiment. Against this
backdrop, strong corporate unda-
mentals, which are usually a orceul
driver o equity returns, continue to
take a back seat to daily headlines
and the periods o heightened volatil-
ity that oten ollow. While investors
could be in or a bumpy ride, we are
generally positive on the prospects
or the U.S. equity market and the
eventual return o undamentals-
driven perormance.
2011: rIsk aversIon surged as
THe year progressed
The U.S. equity market, which began
the year with much promise, was
soon hampered by a confuence
o events that resulted in a signi-
cant fight to quality and, at times,
indiscriminate selling. The shit rom
robust risk appetite (risk on) to
risk aversion (risk o) began in the
late spring. Ater a period o resil-iency in the wake o the uprisings in
the Middle East and the devastating
earthquake in Japan, investor senti-
ment started to sour. Data pointed to
moderating economic growth, and
ears o Greece deaulting on its debt
obligations again took center stage.
Risk aversion gained momentum in
the third quarter due largely to the
downgrade o U.S. Treasuries by Stan-
dard & Poors. Mied economic data,
ears o contagion rom the European
sovereign debt crisis, and growing
epectations or a double-dip reces-
sion compounded investor concerns.
At times, investors were willing to
park their money in Treasuries earning
minimal returns as they took shelter
in the rising storm. Despite a strong
rally or stocks in October, inves-
tor goodwill soon aded with new
concerns in Europe, including ears
about Italian debt and a surge in the
countrys borrowing costs. Political
gridlock in Washington also came to
a head as the debt-reduction super
committee ailed to reach a compro-mise to meet budgetary targets by
the agreed-upon deadline.
economy, FronT and cenTer
As we look ahead to 2012, the
economy, as usual, will be central
to the health o the stock market.
Unortunately, economic data have
been less than conclusive in gauging
a clear course or recovery. Consumer
and business spending, manuactur-ing activity and other metrics have
fuctuated rom month to month,
leading to shiting epectations by
turn rom epansion to contrac-
tion and back again. However, two
constants remain: elevated unemploy-
mentrecently at nearly 9%and
weakness in the housing market,
which has had little momentum ater
U.S. Equities:In the Back Seat Now, Fundamentals Should Eventually Drive Resultslh miii, mti-at c sttit
-
7/31/2019 Solving for 2012
17/516 Neuberger Berman
dramatic declines in volume and pric-
ing. These actors, combined with wor-
ries about global macro developments,
have in turn negatively impacted
condence and consumption.
Still, we think the U.S. economy has
enough momentum to avoid a dou-
ble-dip recession in 2012, and grow
at a positive, even i subpar, pace.
Among the actors that could poten-
tially support growth are the sizable
cash holdings o many companies
that have been hesitant to deploycapital in an uncertain environment.
I condence improves, the increased
use o this cash could augment
GDPas could a positive change in
spending by consumers, who have
been relatively conservative in their
spending over the past several years.
Even i the U.S. alls back into reces-
sionwhich we see as the less likely
scenariowe think it would probably
be relatively shallow, due to what
we consider to be a lack o ecesses
in the economy. In the housing
sector, or eample, construction
starts, residential sales and home
prices all declined dramatically or
several years, and appear to have
little room to all urther rom todays
depressed levels. Corporations, hav-
ing cut costs during the depths o the
economic crisis, are operating leanly,aided by healthy balance sheets and
inepensive nancing. We believe
deault rates on company debt are
likely to come in below average net
year. Indeed, given modest infation
numbers and ears about the econ-
omy, the Federal Reserves monetary
policy is likely to remain accommoda-
tive. This monetary stimulus may be
particularly important given that U.S.
budgetary pressures and political
gridlock suggest that meaningulscal stimulus is unlikely to be put
into place in the coming year.
european deBT saga
conTInues
With unprecedented connectiv-
ity among businesses across global
markets, U.S. economic health will
depend in part on whats happening
elsewherewhether in Berlin, Hong
Kong or Tehran, or that matter. Atthis point, sovereign debtin the
U.S., but particularly in Europecon-
tinues to have an enormous impact
(at least psychologically) on business
and consumer condence as well as
market perormance.
As we write this report, the Euro-
pean situation continues to shit
rapidly. A late October agreement by
European Union members to reduce
Greeces debt by 50% and substan-tially increase the European Financial
Stability Facility (EFSF), designed to
support euro-area member states,
was initially viewed by investors as
a signicant step in quelling the
escalating crisis. However, it soon
became clear that the various players
remain at loggerheads on how to
deal eectively with major issues o
implementation, timing and unding.
Indebted nations bridle under pres-sure to implement austerity mea-
sures and reduce ependitures while
core countries (Germany and France)
have shown reluctance to bear the
brunt o potential bailouts, and the
European Central Bank seems cau-
tious about taking on a larger role in
quelling the crisis.
wIll REBoUnd In mARkEt VolAtIlItY contInUE In 2012?
Number o Trading Days with Intraday Swings Above 3% or S&P 500
0
10
20
30
40
50
60
70
80
11*1009080706050403020100
Source: FactSet. *As o November 30,2011.
coRPoRAtE BAlAncE ShEEtS REmAIn hEAlthY
Percentage o Assets in Cash: S&P 500 Companies (ex Financials)
10%
8
6
4
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: FactSet, through September 30, 2011.
-
7/31/2019 Solving for 2012
18/51Solving or 201
GLOBAL EQUITIES
France and Germany have called or
reworking the European Union (EU)
as a whole and amending Euro-
pean treaties to include centralized
oversight o national budgets andautomatic sanctions against countries
in violation o new stricter rules, at
least or the 17 eurozone countries.
But the U.K. has so ar vetoed the
proposed EU-wide agreement, and
some European voters are voic-
ing complaints as well. Meanwhile,
the prolonged inability to come up
with a decisive to its debt woes
appears to threaten the credit ratings
o even core eurozone countries. All
told, the ongoing uncertainty and
hobbled banking system will likely
impact economic activity in the near
termsomething that new European
Central Bank President Mario Draghi
acknowledged in noting the potential
or a mild European recession by
the end o 2011.
oTHer Issues:
cHInese Hard landIng
Beyond the maneuverings in Europe,
we are keeping a close eye on devel-
opments in China, which have signi-
cant implications or global growth
and the equity markets in 2012. Much
has been written about whether
China has the ability to orchestrate a
sot landing or its economy by end-
ing a two-year tightening cycle that
has included numerous interest rate
increases and higher bank reserve
requirements. Indeed, the countryseconomy has decelerated somewhat,
rom 10.4% GDP growth in 2010, to
around 9.2% or 2011.
I the Chinese governments mea-
sures to cool the property market
and tame infation turn out to have
been too heavy-handedespecially
with economic pressures mounting in
the developed worldthe resulting
slowdown could substantially impact
global business activity. From ourperspective, although Chinas eco-
nomic epansion is likely to urther
moderate in 2012, we dont believe
the country will eperience anything
too severe. Chinas infation rate now
appears to be at, or near, a peak
while its property market has shown
signs o cooling. As a result, we think
that Chinese policymakers have the
feibility to stop or potentially reverse
course on their tightening measures
in pursuit o the elusive sot landing.
elecTIon grIdlock?
Finally, one issue that is a bit harder
to handicap is the potential impact
o election politics in 2012, when
the U.S. will choose its President and
both the House and Senate have
the potential to change hands. (See
2012 Election on page 19.) Despite
etensive wrangling, little progress
has been made toward reducing the
ederal budget decit and level o
ederal debt, which has now reached
a staggering $15 trillion. Moreover,
should the economy soten, as noted,
it seems unlikely that there would be
agreement on any major stimulus.
Indeed, given the political games-
manship displayed during the debt
ceiling crisis and with the ailure o
the Congressional super committee
to reach budgetary compromise, we
think that the run-up to the election
will only intensiy current polarization
and etend gridlock. This, in turn,
could infuence Standard & Poors and
other rating agencies as they consider
a potential urther downgrade o U.S.
Treasuries, as well as the willingness
o businesses to make major invest-ments in equipment or hiring in an
uncertain environment. Although
there may be some movement on ta
reorm, it seems that the most impor-
tant policy initiatives will probably
have to wait until ater November.
WHaTs aHead For sTocks
Many o the key issues acing the
worlds governments and economies
will likely take time to play out. Assuch, we think that the short-term
movements o the U.S. equity market
in 2012 will continue to hinge on
UncERtAIntY, mAcRo FocUS hEIGhtEnEd coRRElAtIon AmonG StockS
S&P 500 Industry Groups: 30-day Roll ing Correlation
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
20112010200920082007200620052004
Source: FactSet, through November 30, 2011.
-
7/31/2019 Solving for 2012
19/51
-
7/31/2019 Solving for 2012
20/51
Politicians have long recognized therelationship between voter approval
and the state o the nancial markets
and economy. This is most evident in
U.S. presidential election years, when
campaign promises and stimulus
packages become the norm and tend
to benet stocks. In 2012, however,
things could be a bit dierent. Histori-
cally, presidential cycles and U.S. stock
markets have ehibited some recurring
trends, with equity market returnstending to be stronger in the third and
ourth years o presidential administra-
tions, as incumbents have pumped
stimulus into the economy in hopes
o urthering their reelection chances.
Since 1926, the S&P 500 total return
has averaged 8.2%, 9.0%, 19.4% and
11.0% in years 1, 2, 3 and 4, respec-
tively, o each presidential term.
Under President Obama, however,
equity returns have been ront-loaded,with the S&P 500 returning 26.5%
and 15.1% in his rst (2009) and
second (2010) years as President, andonly 1.1% year-to-date as o Novem-
ber 30, 2011. To be air, the market
environment throughout Obamas
tenure to date has been tumultuous
early gains refect the rebound rom
the depths o the March 2009 market
lows, while more recently the Euro-
pean debt crisis and economic ears
have had a dampening market impact.
an ausTerITy elecTIonLooking toward 2012, we do not
epect major stimulus measures to
be enacted by the ederal govern-
ment, as has oten been the case
in an election year. Fears over debt
levels and the vast political divide in
Congress have simply changed the
debate. Instead o proposing ta cuts
and spending increases, politicians are
generally contemplating ta increases
and spending cuts. All things beingequal, such austerity measures will
likely be a drag on economic growth.
As some will observe, the economyis not the stock market and the stock
market is not the economy. We agree,
but the 2012 elections are particularly
uncertain, with the President appearing
to be hanging on by a thread and the
major political parties deending slim
margins in the House and Senate.
Moreover, ta reorm, health care
regulation, international trade and
many other issues are still up in the
air and may not be decided until aterNovember 6. This will likely prompt
businesses and individuals to take a
cautious approach until greater
clarity emerges.
As a result, we anticipate the elec-
tions to have a dampening eect on
both the economy and stock market
in 2012i we do happen to reach
the 11.0% average S&P 500 return or
year 4 o the election cycle, I highly
doubt it would be a result o govern-ment largesse.
oBAmA And thE Stock mARkEt
S&P 50 0 Total Return by Presidential Year
Source: FactSet. Year 3 Obama data through November 30, 2011.
Historical Average Obama
0
5
10
15
20
25
30%
Year 4Year 3Year 2Year 1
2012 Election: An Exercise in Austeritymtthw l. rbi, dit Itt stt
This material is provided or inormational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold asecurity. The views expressed herein are generally those o Neuberger Bermans Investment Strategy Group (ISG), which analyzes market and economic indicators to developasset allocation strategies. ISG consists o fve investment proessionals who consult regularly with portolio managers and investment ofcers across the frm. This materialmay include estimates, outlooks, projections and other orward-looking statements. Due to a variety o actors, actual events may dier signifcantly rom those presented.Any views or opinions expressed may not reect those o the frm as a whole. Investing entails risks, including possible loss o principal. Indexes are unmanaged and are notavailable or direct investment. Past perormance is no guarantee o uture results.
Please see disclosures at the end o this publication, which are an important part o this article.
-
7/31/2019 Solving for 2012
21/510 Neuberger Berman
With so much uncertainty in the
past years global equity markets,
courtesy o the eurozone sovereign
debt crisis, investors may wonder
how much appeal an international
equity allocation holdsespecially as
the crisis and related concerns remain
an ongoing risk. In our opinion,
plenty. We think a global perspective,
along with a bottom-up, quality-
and valuations-ocused investment
approach, can continue to uncoverattractive long-term opportunities or
both appreciation and diversication,
and help mitigate many o the
risks associated with a tougher
macroeconomic backdrop.
From a regional perspective, we think
its critically important or investors
to dierentiate between sources o
opportunity and sources o aniety
in the developed international arena.
The weak perormance o the MSCI
EAFE Inde in 2011 was clearly driven
by the eurozone, with its news o
downgrades, potential deaults and
bailout-related political concerns.
The eurozone continues to garner
attention, as the debt accumulated
by the weaker GIIPS economies1
strains stronger nations such as
Germany, and taes the capabilities
o the European Financial Stabil-
ity Facility and commitment o itsmember states. Additionally, austerity
programs and higher taes aimed at
reducing large decits, while neces-
sary or the longer term, will likely
continue to impede growth and
weaken consumer and business
sentiment in the near term. This
suggests that serious challenges
remain as the region works toward
economic stability.
While the U.K. is not part o the euro-
zone, the outlook there seems airly
unappealing or many o the same
reasons. The U.K. has high levels o
consumer and government debt, as
well as large government decits.
Attempts to cut government spend-
ing have met with signicant resis-tance and have acted as a drag on an
already slowing economy. This con-
trasts with other non-eurozone coun-
tries like Switzerland and the Nordic
region that oer more economic
and scal stability. On the other side
o the globe, Japan struggles with
an aging demographic prole, high
public debt levels, and an eport sec-
tor eposed to an appreciating yen
and slowing global economylikely
a recipe or continued anemic growth
going orward. Elsewhere in Asia, and
more broadly in emerging markets,
new middle class consumers and
corporations oer opportunity or
growth and investment.
navIgaTIng Weaker markeTs
With most mature economies seeking
to reduce scal decits, we believe
economic growth in the developed
world is likely to remain weak. As a
result, infation should stay subdued,
and interest rates can remain at low
levels. We believe that spending
will remain weak, and thereore see
little appeal in companies that rely
on a buoyant consumer in Europe or
Japansuch as auto manuacturers
and more appeal in companies with a
more deensive customer prole. We
also believe that prospects or multi-
national businesses with established
operations in North America and
Emerging Markets are more attractive
than those with operations ocused onEurope or Japan. A number o Europe-
based companies have many decades
Developed International Markets: Looking Beyond the EurozoneBji s, cFa, pti m H gb eit T
EURozonE lIkElY to lAG, whIlE Em ShoUld lEAd GloBAl GRowth
% Year-over-Year Economic Growth
pjti
2010 2011 2012
Eurozone 1.8 1.6 1.1
United Kingdom 1.4 1.1 1.6
United States 3 1.5 1.8
Canada 3.2 2.1 1.9
Japan 4 -0.5 2.3
Emerging Markets 7.3 6.4 6.1
World Output 5.1 4 4
Source: IMF World Economic Outlook, September 2011.
1. Greece, Italy, Ireland, Portugal and Spain.
-
7/31/2019 Solving for 2012
22/51Solving or 201
This material is provided or inormational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold asecurity. Investing entails risks, including possible loss o principal. Indexes are unmanaged and are not available or direct investment. Past perormance is no guaranteeo uture results.
Investing in oreign securities involves greater risks than investing in securities o U.S. issuers, including currency uctuations, interest rates, potential political instability,restrictions on oreign investors, less regulation and less market liquidity. Investing in emerging market countries involves risks in addition to those generally associated withinvesting in developed oreign countries. Securities o issuers in emerging market countries may be more volatile and less liquid than securities o issuers in oreign countrieswith more developed economies or markets.
Please see disclosures at the end o this publication, which are an important part o this article.
o eperience operating in emerging
markets, oer strong corporate gover-
nance and transparency, and trade at
attractive valuation levels today.
Within Europe and Japan, we believe
deensive sectors like health care
and consumer staples hold appeal.
We also nd certain segments o the
consumer discretionary sectors attrac-
tivesuch as cable TV and satellite
broadcastingwhere many compa-
nies maintain a recurring stream o
revenue that tends to be insensitive to
the economic backdrop. We also view
parts o the inormation technology
and industrial sectors in the samelight, as many companies in these
areas derive most o their prots rom
maintenance or service revenue.
Even in mature markets, we believe
that telecommunications spending will
continue to rise, as consumers adopt
more data-intensive devices and appli-
cations. Within this area, we believe
that cellular operators and equipment
suppliers are likely to benet rom
greater volumes and capital spending.
In contrast, we are generally pes-
simistic about the nancial sector, as
we believe that the developed world
is in a prolonged period o deleverag-
ing. Credit markets globally remainvulnerable to policy in Europe, which
represents an area o potential risk
that it seems prudent to avoid.
IdenTIFyIng areas oF sTrengTH
In Europe, once one steps outside
the markets at the center o the debt
issue, we believe there are attractive
investment opportunities. Countries
such as Norway and Switzerland are
good eamples. Norway has retainedits own currency, has limited public
debt, and maintains signicant oil
reserves. Switzerland has also re-
tained its currency and is home to
several world-class global health care
and consumer staples companies that
operate in a variety o developed and
emerging markets. Similarly, while we
epect the U.K. economy to remain
lackluster, there are solid companies
in Britain that appear well-positionedwith global brands and operations.
From our perspective, a well-rounded
approach to international equity
investing should also consider non-
EAFE inde eposure. The Canadian
economy ared well through theglobal nancial crisis o 2007-09,
and is home to some o the worlds
leading energy, precious metals and
agricultural commodities companies.
Emerging markets include many com-
panies that are relatively insensitive to
policy changes in their home markets
and oer a strong strategic position
in global markets.
Overall, we believe that international
markets oer compelling valuations
and select areas or secular growth.
While there are countries and sec-
tors to avoid, we think there are also
world-class opportunities or long-
term investors willing to look beyond
the headlines.
GLOBAL EQUITIES
-
7/31/2019 Solving for 2012
23/512 Neuberger Berman
Emerging Markets: Real Growth in a Weakening Global Economyc a. sh, cFa, pti m gb eit T
Ater sharp losses stemming rometreme risk aversion during 2011,
we believe emerging markets
(EM) equities may be poised or a
reboundrst or larger-capitalization
stocks and then smaller-cap issues. In
our view, undamentals remain strong
and, ater the sell-o, valuations
have become compelling. Perhaps
most importantly, compared with the
headwind that we epect developed
market companies to eperience, EMcompanies are currently beneting
rom real secular growth. While risks
remain, including domestic infation
and ongoing global economic pres-
sures, we believe that EM companies
ocused on meeting domestic demand
have attractive return potential in the
year ahead.
sell-oFF In 2011 WasIndIscrImInaTe
As 2011 began, loose monetary policy
in the developed markets helped push
commodities and energy prices higher.
This caused EM central bankers to
ocus on taming infation. The need
or vigilance was particularly pertinent
in high-growth economies such as
China, India and Brazil, and policymak-
ers embarked on monetary tightening
programs in an eort to limit the risko their economies overheating. While
this made sense economically, the
policy caused EM investors to worry
about slowing growth. In the second
hal o the year, the European sover-
eign debt crisis intensied. This, along
with signs o slowing growth across
the major developed economies, and
a potential hard landing or the Chi-
nese economy, led markets to a period
o massive risk aversion.
Given the risk-aversion sentiment,although undamentals generally
remained strong, investors sold o
EM equities. This risk-o trade began
in the third quarter, with the MSCI
Emerging Market Inde declining
22.5%, the worst perormance since
the ourth quarter o 2008. Now, with
valuations at attractive levels, and rela-
tively superior economic growth rates,
we view this as an attractive time or
investors with a longer-term view toreconsider emerging markets.
secular groWTH and THe
domesTIc advanTage
From our perspective, the secular
advantages emerging markets enjoy
over developed markets have only
increased, driving and sustaining their
longer-term growth trajectories. Gross
domestic product (GDP) growth is
highin act, some research suggests
EmERGInG mARkEtS: UnPARAllElEd GRowth At A low PRIcE
MSCI Emerging Markets MSCI World
Forward Price/Earnings* Forward EPS Growth Rates
0
5
10
15
20
25
30
35
11/119/113/119/103/109/093/099/083/089/073/079/063/060
5
10
15
20
25%
11/119/113/119/103/109/093/099/083/089/073/079/063/06
Sources: MSCI, FactSet, RIMES. Data as o November 30, 2011.* Based on one-year estimates. Based on 3-5 year earnings-per-share growth rates.
1. Source: Morgan StanleyGlobal Economics, August 2011.
-
7/31/2019 Solving for 2012
24/51Solving or 201
that up to 80% o global GDP growth
will be generated rom the emerging
markets in 2012.1 In addition, emerg-
ing markets countries tend to have
strong balance sheets versus the overlyindebted developed market countries.
Longer term, we believe one o the
most important secular drivers or EM
economies is their demographic pro-
le: Young and growing populations
are rapidly increasing their standards
o living and consumption habits,
driving growth or many domestically
ocused consumer staples, consumer
discretionary and health care com-
panies. These countries also have tospend on local inrastructure that will
benet local growth, improving e-
ciency and raising capacity.
A new positive shit weve seen is
taking place within emerging markets
eport sectors, which have tradition-
ally been aimed at developed markets.
In light o a slow global economy,
intra-emerging markets trade has been
the key growth driver or the eport
sector, and has resulted in more
eports remaining in EM. Clearly, com-
panies with the brand, distribution and
eposure to other growing economies
appear, at this point, better positioned
than those relying on developed mar-
kets or their growth.
In terms o market capitalization, we
see the most compelling valuations
in small- and mid-cap stocks, as they
underperormed or much o 2011
when investment und fows migrated
out o EM. With a longer-term view,
we think they oer an attractive risk/
reward prole as, in general, they are
well-positioned to benet rom thedomestic growth.
Issues remaIn BuT
are relaTIve
The types o issues we see in emerg-
ing markets can be categorized either
as eogenous (such as eects o
the global economic slowdown, EM
investor behavior and liquidity issues)
or internal (infation or sub-optimal
growth). While any o these couldimpact equity market perormance, we
take comort in the idea that strong
secular growth stories with solid
company and economic undamen-
tals should hold investment appeal,
particularly in light o the challenges
acing developed equity markets.
Regarding infation, while emerg-
ing markets companies continued to
see strong growth in 2011, higher
raw material and input costs as wellas higher wages created some mar-
gin pressure. We think these eects
will start to taper o; and, rom an
earnings growth standpoint, we
continue to eel more comortable
with the domestically oriented sec-
tors. To maintain growth in a slowing
global economy, many countries are
either already cutting rates or near-
ing the end o tightening cycles. In
cases where infation has remained
airly sticky, as in China and India,
policymakers appear to want to see
evidence that infation has abated
beore making denitive moves. On
the other hand, in Turkey, Indonesiaand Brazil, rate cuts are already under-
way. For Brazil, specically, high rates
had strengthened the real, which has
hurt eport sectors. A surprise rate cut
last summer was aimed at removing
some o the upward currency pres-
sure. The act remains, however, that
there is structural infation in emerg-
ing markets, with wages increasing
considerablywhich, in part, also
uels strong domestic demand. To help
increase productivity and oset wage
pressures, investments in capacity will
be needed. A general lack o capac-
ity is an ongoing problem hampering
overall growth, but it provides another
secular investment theme ocused on
industrial and materials companies.
cauTIous opTImIsm
As we look to the year ahead, we are
cautiously optimistic. When the market
returns to ocusing on the unda-
mentals, we think domestically driven
emerging markets companies could be
a real growth story or 2012.
GLOBAL EQUITIES
This material is provided or inormational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or holda security. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates.Investing entails risks, including possible loss o principal. Indexes are unmanaged and are not available or direct investment. Past perormance is no guarantee outure results.
Investing in oreign securities involves greater risks than investing in securities o U.S. issuers, including currency uctuations, interest rates, potential political instability,restrictions on oreign investors, less regulation and less market liquidity. Investing in emerging market countries involves risks in addition to those generally associated withinvesting in developed oreign countries. Securities o issuers in emerging market countries may be more volatile and less liquid than securities o issuers in oreign countrieswith more developed economies or markets.
Please see disclosures at the end o this publication, which are an important part o this article.
-
7/31/2019 Solving for 2012
25/514 Neuberger Berman
Greater China: Challenges, Select OpportunitiesF y, si pti m gt chi eit T
In recent years, China has achieved
generally stable and rapid economic
growth, averaging 10% gross domes-
tic product (GDP) growth in the last
31 years, and 9.4% in the rst three
quarters o 2011.1 As we look to 2012,
however, the sluggish world economy
and market volatility may pose sig-
nicant challenges or investors. Does
the Greater China region continue to
provide opportunities? In our view,
the answer is yes, especially in view
o 2011 market declines; althoughselectivity, as always, will be important
in this relatively volatile segment o the
worlds capital markets.
groWTH remaIns sTrong,
valuaTIons compellIng
Projected growth rates or China,
albeit lower than those seen recently,
remain strong. The Chinese govern-
ment has targeted GDP growth o
approimately 7% or the net ve
years,2 and we anticipate Chinese GDP
growth rates o 8.5% and 8% over the
net three and ve years, respectively. I
GDP growth rates or other economies
remain in line with consensus estimates,
these gures would be among the
highest in Asia and about two times
that o U.S. and Europe combined.
Chineseper capita GDP and private
consumption are much lower than
those o other major economies. Thisrefects the vast gap in living standards
between China and developed econo-
mies and, we believe, supports the case
or continued strong growth.
Also important, bargain-hunting
opportunities have emerged ollowing
the recent market corrections, with
valuations near 2008 lows despite
what we consider to be very strong
earnings potential. For eample, the
trailing 12-month price/earnings ratio
or the MSCI China Inde was 8.4 as
o September 30, 2011.3 This is despite
projected 2012 earnings-per-share
growth in the low teens or MSCIChina and mid-teens or the China
A-shares market.
underWeIgHTed In
gloBal IndIces
In our view, Greater Chinas weight-
ing in global indices does not prop-
erly refect its size, importance and
infuence in relation to global markets.
Mainland China is the worlds largest
emerging market and Greater China4(including Hong Kong and Taiwan) is
the second-largest equity market in
terms o market capitalization. How-
ever, the MSCI global indices only
include a subset o the Greater China
markets and do not refect the entire
opportunity set. The MSCI World Inde
contains only Hong Kong companies
listed in Hong Kong, which represents
just 1.3% o the inde total.5 Mean-
while, China is captured in the MSCIEmerging Markets (EM) Inde only as
mainland Chinese companies listed in
Hong Kong, and comprises 17.3% o
the inde (see display)6 versus 15.3%
or Brazil. In act, Greater China has
a market capitalization o over three
times that o Brazil, but the market is
under-represented by global indices
because only a portion o it is cap-
tured. In our view, this misalignment
underscores the magnitudeand,
thereore, the opportunity seto the
potential investment universe within
the Greater China equity markets (see
display on page 25).
sHIFT ToWard domesTIc
consumpTIon
Historically, GDP growth in China
has been driven by government
investment. Today, although still the
worlds largest eporter, the country
is becoming less dependent on ed
asset investment and oreign trade or
growth, refected by its standing as
the worlds second-largest importer.
In the rst three quarters o 2011,
growth o imports outpaced that o
eports, up 26.7% versus 22.7%,
respectively.7 Another key metric is
retail sales, which we consider an
important indicator o domestic con-
sumption. Retail sales rose 17.7% year-
over-year in September 2011 and 17%
in the rst three quarters o 2011.8 We
believe these shits in Chinas growth
model will contribute to the sustain-
ability o its long-term epansion.
1. National Bureau o Statistics o China.2. Outlines or the 12th Five-Year Plan on National Economic and Social Development, March 2011.3. Bloomberg, as o September 30, 2011.4. Greater China includes companies incorporated, organized under the laws o, or that have a principal ofce in, the Peoples Republic o China, Hong Kong SAR, Macau
SAR or Taiwan. It also includes companies that derive a majority o their revenue or profts or that have a majority o their assets in mainland China or Taiwan.5. Barclays Capital, as o August 31, 2011. Greater China represents Hong Kong companies listed in Hong Kong, which is in the MSCI World Index.6. Barclays Capital, as o August 31, 2011. China represents Mainland China companies listed in Hong Kong, which is in the MSCI Emerging Markets Index.7. Chinas Foreign Trade to Top $3 trillion This Year: Ofcia l, China Daily, October 29, 2011.8. Total Retail Sales o Consumer Goods in September 2011, National Bureau o Statistics, China.
-
7/31/2019 Solving for 2012
26/51Solving or 201
GLOBAL EQUITIES
InFlaTIon concerns aBaTe
Throughout 2011, the Chinese
government grappled with balanc-
ing slowing growth and the potentialor high infation. Since September
2010, the Peoples Bank o China
(the countrys central bank) has been
active in its tightening policyrais-
ing benchmark interest rates ve
times and increasing the reserve
requirement ratio or major banks to
a record 21.5% rom 17% last year.9
However, o late, policymakers have
eased these measures due to poten-
tial concerns over social unrest and
slowing growth.
Overall infation (as represented by
the Consumer Price Inde) peaked in
July 2011 at 6.5% and has gradually
decreased, easing to 6.2% in August
2011 and dipping slightly below 6.1%
in September 2011.10 We epect infa-
tion o approimately 5% or the last
quarter o 2011. Compared with the
countrys savings rate o approimately
3.5%, the real savings rate (ater infa-
tion) is still negative. While we believe
it remains too early to conrm that
infation has abated, we eel that the
easing to date is a positive indicator.
amId sloWIng, look To
IndusTry leaders
Looking ahead to 2012, Chinas eco-
nomic prospects will likely be aected
by slower projected growth in the
U.S. and Europe. However, we think a
healthy job market supported by ris-
ing wages reinorces the potential or
select opportunities in sectors driven
by economic growth and consump-
tion, such as consumer discretionary
and consumer staples. Within these
sectors, we are more optimistic about
companies that are leading players in
their respective industries, with high
top- and bottom-line visibility, stable
and recurring operating cash fows,
and robust distribution channels.
More broadly, although short-term
uncertainties persist, we believe the
Greater China equity markets are
at compelling valuations and seem
likely to rebound during the coming
year. In our view, taking a bottom-
up approach using on the groundresearch will be the best way to try to
limit the potential pitalls and capital-
ize on the opportunities in the region.
9. Corporate Yield Gap Shrinks as China Curbs Ease, Bloomberg, October 30, 2011.10. National Bureau o Statistics o China.
This material is provided or inormational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold asecurity. Investing entails risks, including possible loss o principal. Indexes are unmanaged and are not available or direct investment. Past perormance is no guaranteeo uture results.
Please see disclosures at the end o this publication, which are an important part o this article.
chInA IndEx wEIGhtInGS UndERwEIGht mAjoR mARkEt
Growth, Market Capitalization o LargestEmerging Equity Markets
12%
10
8
6
4
2
0
0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000
GDP Real Rate (% as of July 2011)
Market Capital ($ in billions as of September 30, 2011)
India
MainlandChina
Brazil
South Korea
Taiwan
Mexico
Turkey
Russia
Malaysia
Source: Bloomberg and CIA World Fact Book, as o September 30, 2011. Size o circlerepresents size o market capitalization. Mainland China includes A and B shares only.
Others2
17.25%
6.95%
6.74%
7.89%
10.99%
17.64%
14.38%
15.32%
2.83%
Taiwan
South Afr
Russia
Korea
Indonisia
India
China1
Brazil
MSCI Emerging Markets Index Constituents
Source: Barclays Capital, as o August 31, 2011.1. China represents Mainland China companies listed in Hong Kong, which is in the
MSCI Emerging Markets Index.2. Others include Chile, Colombia, Czech Republic, Egypt, Hungary. Malaysia, Mexico,
Morocco, Peru, the Philippines, Poland, Thailand, Turkey.
-
7/31/2019 Solving for 2012
27/51
GLOBAL FIxED INCOME
-
7/31/2019 Solving for 2012
28/518 Neuberger Berman
Overview: Despite Uncertain Economy,A Generally Positive Outlook
B T, chi Itt of Fix I
level o pessimism. Overall, despite
a host o macro uncertainties, we
are generally positive about the
various sectors o the global ed
income market.
a look Back
The rst quarter o 2011 and much
o the remainder o the year were
a study in contrasts or the ed
income market. When the year
began, there were epectations or
a strengthening global economy
and infationary concerns. In the
rst quarter, despite many geopo-
litical issues, the ongoing European
sovereign debt crisis and the dev-
astating natural disasters in Japan,
most spread sectors outperormed
equal-duration Treasuries and U.S.
Treasury yields moved higher across
the curve. However, beginning in late
spring, global growth moderated and
investor risk appetite was replaced
with risk aversion. The risk o
trade gained momentum in the third
quarter o the year due in part to a
lack o U.S. scal discipline resulting
in Standard & Poors Treasury rating
downgrade, disappointing economic
data that triggered epectations or
a double-dip recession, and ears o
contagion rom the European sov-
ereign debt crisis. At one point in
September, the yield on the 10-year
Treasury ell to levels not seen since
the 1940s. At this point, it appears
that many spread sectors may gener-
ate positive returns in 2011, but lag
equal duration Treasuries.
gloBal economIc uncerTaInTy
Against such an uncertain backdrop,
the ollowing is our base case or
2012, albeit with several caveats given
the unolding situation in Europe,
evolving scal and monetary poli-
cies around the globe and questions
regarding Chinas ability to orchestrate
a sot landing or its economy.
What is crystal clear is the act that
the global recovery has lost some
momentum. Leading indicators across
the globe point to a slowdown that is
broad-based. Whats more, consumer
spendingthe true driver o an
economic epansionremains weak
as households deleverage and repair
their balance sheets. These head-
winds, coupled with a growing push
or scal consolidation and sovereign
debt reduction, lead us to believe
that global growth will remain below
trend in the short to medium term.
In the midst o elevated levels o risk
aversion and deteriorating macro-
economic undamentals, we eel that
eceptional stimulative measures are
likely to remain in place or longer than
previously anticipated. We also eel thatinterest rates around the globe should
remain relatively low. This is a potential
recipe or solid results rom many sec-
tors in the global ed income market.
Given spread widening that occurred
during recent fights to quality, we now
nd many spread sectors to be attrac-
tively valued.
The economic picture is clouded with an unusual number o macro issues that could potentiallyundermine global growth in 2012. However, should some o these issues be resolved or even become
less negative, the result could be an upside surprise or the global economy, given the current
-
7/31/2019 Solving for 2012
29/51Solving or 201
GLOBAL FIxED INCOME
We epect U.S. growth to remainmodest, but generally positive, as
the economy adjusts to tighter scal
conditions. Easy monetary conditions,
ample liquidity and stronger balance
sheets or both consumers and cor-
porations (higher savings rate or the
ormer and signicant amounts o cash
and etended debt maturities or the
latter) should, in our view, provide an
improved environment or consumer
spending and, thus, U.S. growth.
We think unemployment will remain
elevated but begin to drit lower.
Overall, in our opinion, GDP growth
will most likely be between 1.5% and
2.5% in 2012.
InTeresT raTes and InFlaTIon
We have a airly negative outlook or
Treasuries given recent valuation levels.
The outright level o rates, a multi-
decade low, refects a substantial
amount o risk/uncertainty premiumsassociated with the European situa-
tion, epectations or a U.S. recession
and potential or a defationary envi-
ronment. Given low Treasury yields,
any material change in sentiment and/
or positive surprises in economic data
will, in our view, result in negative
absolute returns or the asset class in
2012. We epect the trading range
or the 10-year U.S. Treasury to be
between 2% and 3% or 2012 and
or the ve-year Treasury to fuctu-
ate between 0.9% and 1.6%, given
the Feds commitment to keeping the
Federal Funds rate anchored in a his-
torically low range between zero and
0.25% until mid-2013. The longer end
o the curve (30-year maturities) has
the potential to be more volatile and
could trade between 3.0% and 4.4%
in 2012. We believe headline infation
will moderate rom 4%, while core
CPI should remain relatively steady
given the large positive gap betweenheadline and core CPI.
InvesTmenT grade credIT
While the near-term outlook or the
credit market is cloudy, we eel the
intermediate- to longer-term picture
remains bright. Near term, a number
o macro actors could overshadow
generally strong undamentals which
typically drive the perormance o the
credit market. These actors includeconcerns about contagion rom the
European sovereign debt crisis and
ears o a recession in the U.S. While
the situation in Europe remains fuid,
it is our belie that a resolution will
eventually occur. We also eel that the
U.S. will skirt a double-dip recession.
When some o the uncertainties
regarding the macro headwinds lit,
investor sentiment could improve,
providing a tailwind or the credit
PRIcInG In A REcESSIon, InVEStmEnt-GRAdE cREdIt APPEARS AttRActIVE
Source: Morgan Stanley, Moodys, the Yield Book, Federal Reserve. Data through October 31, 2011.
0
100
200
300
400
500
600
700
800
Spread to Treasury (bps)
BBBs (to Treasury)U.S. Recession AAA/AA (to Treasury)
200519951985197519651955194519351925
8081 Recession
S&L Crisis 9091 Recession
2001 Recession
Corporate Malfeasance
Credit Crisis
U.S. Economy, Rates and Sectorsaw a. Jh, chi Itt of Itt g Fix I
-
7/31/2019 Solving for 2012
30/510 Neuberger Berman
market. Further supporting the credit
market is the undamental backdrop.
Overall, corporate balance sheets
are generally strong, with record
amounts o cash on their books. Inaddition, unlike the 2008 credit crisis,
U.S. banks have recapitalized, there
is ample liquidity, deault rates are
etremely low and we epect to see
more upgrades than downgrades.
Furthermore, corporations continue
to enjoy eceptionally low borrowing
costs and, given the low interest rate
environment, we believe demand or
the asset class will again be robust.
Given this outlook, we epect to
see investment-grade bond spreads
tighten in 2012.
resIdenTIal morTgage-Backed
securITIes
We are generally positive regarding
the agency mortgage-backed securi-
ties (MBS) market in 2012. Valuations
are airly attractive rom a historical
perspective and undamentals are
encouraging overall. In our view,
prepayment risks are muted, given
the high percentage o mortgages
that remain under water due to the
prolonged downturn in the housingmarket. Agency MBS are also a rela-
tively high-quality spread sector, which
could prove advantageous during
periods when there are heightened
concerns over credit risk. Also support-
ing the agency MBS market, in our
opinion, is the Federal Reserves initia-
tive to reinvest coupons and principal
payments rom its holdings o agency
debt and agency mortgage-backed
securities into agency MBS. The main
risk to our outlook comes in the orm
o unepected regulatory actions. In
particular, prepayment risks would
increase i the ederal government is
successul in introducing measures to
help homeowners who have negative
equity renance their mortgages.
In our view, the prospects or the non-
agency residential mortgage-backed
securities (RMBS) market are also
encouraging. A number o technical
actors, including the Federal Reserve
Bank o New Yorks attempts to sell
its stake in Maiden Lane II LLC in the
open market, caused non-agencyRMBS spreads to widen during the
spring o 2011. The downturn in this
sector resumed as the general shun-
ning o credit risk continued through
the summer and all. As a result, we
eel that non-agency RMBS loss-
adjusted yields havent been this
attractive since mid-2009. Fundamen-
tals in this market are also generally
benign, as we do not epect to see
signicant urther deterioration in
the housing market. In addition, we
could see urther progress between
regulators and mortgage originators/
servicing companies regarding the
servicing and oreclosure process. This
could positively impact the oreclosure
timeline, which, we believe, would be
benecial or the overall RMBS market.
REAl RAtES dRoP In PoSt-REcESSIon EnVIRonmEnt
10-Year Treasury and Fed Fund s Historical Real Rate
Source: Yield Book; data through October 31, 2011.
-2
-1
0
1
2
3
4
5
6%
2011200920072005200320011999199719951993199119891987
Fed Funds Real Rate 10-Year Treasury Real Rate
-
7/31/2019 Solving for 2012
31/51Solving or 201
Given the underlying undamentals
and current spread levels, we have a
positive outlook or the high yield/
bank loan market in 2012. From a
undamental perspective, despite
moderating economic growth, cor-
porate prots have generally been
solid and leverage levels are manage-
able. Furthermore, in our view, the
large amount o cash sitting idle on
corporate balance sheets providessomething o a cushion i economic
growth weakens urther. We also
eel that implied deault levels may
be overstated. In our view, deault
rates will not materially increase in
the net several years, even i the
U.S. slips back into a recession. The
usual catalysts or deaults have
signicantly dissipated, as bond and
loan maturities have been etended,
bank covenant packages have been
lightened and the average coupon is
not a signicant cash fow hurdle or
most issuers. More specically, we
anticipate a deault rate o roughly
2% in 2012, versus a historical aver-
age o approimately 4%.
asseT-Backed securITIes
We generally do not nd asset-backed
securities (ABS) to oer compelling
valuations, as their spreads have largely
moved back to their pre-credit crisis lev-els. Additionally, regulatory uncertainty,
especially in terms o how the Dodd-
Frank Act treats securitization going
orward, could negatively impact ABS.
In particular, the use o securitization
by nancial companies has become less
attractive and has resulted in less liquid-
ity in the secondary market.
commercIal morTgage-
Backed securITIesThe risk-o trade caused most spread
sectors to perorm poorly as 2011
progressed, and commercial mort-
gage-backed securities (CMBS) were
no eception. This has presented
what we consider some compel-
ling spreads at the top o the capi-
tal structure tranches in the CMBS
market. Loss severities on liquidated
loans have also not been as bad as
was eared a year ago, as commercialproperty pricesespecially in major
metropolitan marketshave oten
held up better than anticipated.
Potentially undermining our generally
positive outlook are regulatory uncer-
tainties related to the securitization
o commercial mortgages. We also
saw that the CMBS market was highly
susceptible to spread-widening dur-
ing recent periods o heightened risk
aversion. Given the unsettled macro
environment, we acknowledge that a
resumption o the risk-o trade could
negatively impact the CMBS market
in 2012, but we believe that this
would be temporary, as yield spreads
are very attractive or such relatively
high-quality assets.
Treasury InFlaTIon-
proTecTed securITIes
As we approach the conclusion o
2011, Treasury Infation-Protected
Securities (TIPS) seem likely to havegenerated a strong absolute return
or the year, but underperormed
Treasuries. For 2012, we epect TIPS
to deliver positive ecess returns as
break-even infation is epected to
rm. It is our belie that headline
infation data will remain volatile in
2012 and that the Federal Reserves
accommod