The Surprises of 2010

Byron R. Wien
Senior Managing Director g g Tel: 212.583.5055
Email: wien@blackstone.com
Byron's monthly essays are broadly recognized for their insight and perspective. If you would like to receive future monthly market commentary publications by Byron Wien, please email byronwien'scommentary@blackstone.com. b i ' t @bl k t

The Ten Surprises of 2009
1. The Standard and Poor s 500 rises to 1200. In anticipation of a second half recovery in the Poor’s second-half U.S. economy, the market improves from a base of investor despondency and hedge fund and mutual fund withdrawals. The mantra changes from “fortunes have been lost” to “fortunes can still be made.” Higher quality corporate bonds, leveraged loans and mortgages lead the way Gold rises to $1,200 per ounce. Heavy buying by Middle Eastern investors and a worldwide disenchantment with paper currencies drive the price of precious metals higher. In a time of uncertainty, investors want something they can count on as real The price of oil returns to $80 per barrel. Production disappointments and rising Asian demand create an unfavorable supply / demand balance. Other commodities also rise, some doubling from their 2008 lows. Natural gas goes to $9 per mcf Low Treasury interest rates coupled with huge borrowing by the Treasury send the dollar into a serious downward slide. Overseas investors become concerned that the currency printing presses will never stop. The yen goes to 75 and the euro to 1.65 The ten-year U.S. Treasury yield climbs to 4%. Later in the year, as the economy shows signs of recovery, economists and investors shift their mood from concern about deflation to worries about inflation. A weak dollar, rapid growth in money supply and record-setting deficits (over $1 trillion) are behind the change

2.

3.

4.

5.

1

The Ten Surprises of 2009
6. China s China’s growth exceeds 7% and its stock market revives. World leaders credit China’s China s authoritarian government for its thoughtful stimulus policies and effective execution during a challenging period. The Chinese consumer begins to spend more and save less and this shift is behind the unexpected strength in the economy Falling t F lli tax revenues from the financial sector cause New York State to threaten bankruptcy f th fi i l t N Y k St t t th t b k t and other states and municipalities follow. The Federal government is forced to step in and provide substantial assistance. The New York Post screams “When will the bailouts stop?” Housing starts reach bottom ahead of schedule in the fall, and house prices stabilize after dropping 15% from year-end 2008 levels. The Obama stimulus program proves effective and a slow growth recovery begins before year-end. Third and fourth quarter real gross domestic product numbers are positive The savings rate in the United States fails to improve beyond 3%, as most economists expect. The concept of thrift seems to have vanished from American culture. Peak job insecurity and negative growth drive increased savings early in the year, but spending resumes as the economic growth turns positive in the second half, making Christmas 2009 the best ever

7. 7

8.

9.

10. Citing concerns about Iraq’s fragile democratically elected government and the danger of a Taliban-controlled Afghanistan, Barack Obama slows his plan for troop withdrawal in the former and meaningfully increases U.S. military p g y y presence in the latter. In a hawkish speech p he states that the threat of terrorism forces the United States to maintain a strong military force in this strategic area
2

The Ten Surprises of 2010
1. The United States economy grows at a stronger than expected 5% real rate during the year and the unemployment level drops below 9%. Exports, inventory building and technology spending lead the way. Standard and Poor’s 500 operating earnings come in above $80 The Federal Reserve decides the economy is strong enough for them to move away from zero interest rate policy. In a series of successive hikes beginning in the second quarter the Federal funds rate reaches 2% by year-end Heavy borrowing by the U.S. Treasury and some reluctance by foreign central banks to keep b i notes and bonds drives the yield on the 10-year T k buying t db d d i th i ld th 10 Treasury above 5.5%. B k b 5 5% Banks loan more to corporations and individuals and pull away from the carry trade, thereby reducing demand for Treasuries. Obama says, “The suits are finally listening” In a roller coaster year the Standard and Poor s 500 rallies to 1300 in the first half and then Poor’s runs out of steam and declines to 1000, ending where it started at 1115.10. Even though the economy is strong and earnings exceed expectations, rising interest rates and full valuations present a problem. Concern about longer term growth and obligations to reduce leverage at both the public and private level unsettle investors g p p Because it is significantly undervalued on a purchasing power parity basis, the dollar rallies against the yen and the euro. It exceeds 100 on the yen and the euro drops below $1.30 as the long slide of the greenback is interrupted. Longer term prospects remain uncertain
3

2.

3.

4. 4

5.

The Ten Surprises of 2010
6. Japan stands out as the best performing major industrialized market in the world as its currency weakens and its exports improve. Investors focus on the attractive valuations of dozens of medium sized companies in a market selling at one quarter of its 1989 high. The Nikkei 225 rises above 12,000 Believing he must be a leader in climate control initiatives, President Obama endorses g , legislation favorable for nuclear power development. Arguing that going nuclear is essential for the environment, will create jobs and reduce costs, Congress passes bills providing loans and subsides for new plants, the first since 1979. Coal accounts for about 50% of electrical power generation, and Obama wants to reduce that to 25% by 2020 The improvement in the U.S. economy energizes the Obama administration. The White House undergoes some reorganization and regains its momentum. In the November Congressional election the Democrats only lose 20 seats, much less than expected When it finally passes, financial service legislation, like the health care bill, proves to be softer on th industry than originally feared. There is greater consumer protection, more ft the i d t th i i ll f d Th i t t ti transparency, tighter restriction of leverage and increased scrutiny of derivatives, but the regulatory changes for investment bankers and hedge funds are not onerous. Trading volume and merger activity increases; financial service stocks become exceptional performers in the U.S. market

7.

8.

9.

10. Civil unrest in Iran reaches a crescendo. Ayatollah Khamenei pushes out Mahmoud Ahmadinejad in favor of a more public relations adept leader. Economic improvement becomes the key issue and anti-Israel rhetoric subsides. Talks with the U.S. and Europe begin but the country remains a nuclear threat. Pakistan becomes the hotspot in the g y p region because of the weak government there, anti-American sentiment, active terrorist groups and concerns about the security of the country’s nuclear arsenal
4

Surprises Not on the 2010 List

! ! ! ! !

Gold Oil China Commercial Real Estate Tax policy

5

Crowd Sentiment Poll
S&P 500 Composite Index
1560 1500 1440 1380 1320 1260 1200 1140 1080 1020 960 900 840 780 720 660
Extremes Generated when Sentiment Reading: Rises above 61.5% = Extreme Optimism Declines below 55.5% = Extreme Pessimism Sentiment must reverse by 10 percentage points to signal an extreme in addition to the above extreme levels being reached.
Arrows represent extremes in optimism and pessimism. They do not represent buy and sell signals and can only be known for certain (and added to the chart) in hindsight.

Daily Data 1/03/2000 - 12/29/2009 (updated weekly on Wednesday mornings)

S&P500 Gain/Annum When: 12/01/1995 - 12/29/2009 NDR Crowd Sentiment Poll is: Average Value Of Indicator At: Optimistic Extremes (down arrows)= 67.8 Pessimistic Extremes (up arrows)= 45.9 Average Spread Between Extremes = 21.9 * Above 61.5 Between 55.5 and 61.5 55.5 and Below Gain/ Annum -1. 2 6. 3 8. 6 % of Time 35. 8 21. 8 42. 4

1560 1500 1440 1380 1320 1260 1200 1140 1080 1020 960 900 840 780 720 660
S D

2000

M

J

S

D

2001

M

J

S

D

2002

M

J

S

D

2003

M

J

S

D

2004

M

J

S

D

2005

M

J

S

D

2006

M

J

S

D

2007

M

J

S

D

2008

M

J

2009

M

J

S

D

75 72 69 66 63 60 57 54 51 48 45 42 39 36 33
(S574)

Extreme Optimism (Bearish)
69.2 66.8 66.4 67.2 62.0 61.9 67.1 66.1 63.1 59.4

75.7 73.5 68.1 69.6 66.6 67.1 71.9 72.2 70.5 70 5 69.5

12/29/2009 = 65.2

66.7 62.2 58.1

54.5 51.5 48.7 46.0 45.7 40.4 37.6 46.5

53.5 51.9

54.8 55.4 49.7 47.3 43.8 46.6 42.5 38.0 49.9 47.6 46.8

37.1 32.5

33.9

33.9

Extreme Pessimism (Bullish)

75 72 69 66 63 60 57 54 51 48 45 42 39 36 33

30.9

NDR Crowd Sentiment Poll
!" Copyright 2009 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved.

See NDR Disclaimer at

www.ndr.com/copyright.html

. For data vendor disclaimers refer to

www.ndr.com/vendorinfo/ .

Source: Ned Davis Research.

6

MSCI World Index (in USD)
(in US$)

MSCI World Index

1,200 1,090 980 870 760 650 Dec 08 Feb 09 Mar 09 May 09 Jul 09 Sep 09 Oct 09 Dec 09
Minor divergence has developed… the average stock has just begun to lag the cap-weighted averages. Not yet a reason to sell, though

MSCI World Index Daily Advance / Decline Line
950 904 858 812 766 720 Dec 08 Feb 09 Mar 09 May 09 Jul 09 Sep 09 Oct 09 Dec 09
7
Source: The Leuthold Group.

Standard & Poor’s 500 Stock Index
(Monthly Data 12/31/1968 – 11/30/2009 (Log Scale))

1,270 1,070 870 670 470 270 70 1969
(Davis100)

Price Move of: -0.4% to Overvalued (+1 SD) = S&P 500 Level of 1,091.06 -25.7% to Median Fair Value = S&P 500 Level of 813.84 -51.0% to Undervalued (-1 SD) = S&P 500 Level of 536.61

11/30/2009 = 1,095.63

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

S&P 500 Median Price / Earnings Ratio (NDR Calculation) with Historical Median
Very Overvalued +2 SD Overvalued 1 +1 SD 41-Year Median = 16.5 -1 SD Bargains 11/30/2009 = 22.2

34 30 26 22 18 14 10 6 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999
Source: Ned Davis Research.

2002

2005

2008
8

World Market Cap as of 12/31/2003
World Market Cap as of 12/31/2003
Secular Bulls 8.5% 11.5% Other

World Market Cap as of 12/31/2008
Secular Bulls 14.2% 12.0% Other

Secular S l Bears

80.0% 80 0%

Secular Bears

73.8%

Countries in Secular Bull Markets
Market Cap as a % of World Market Cap in 2003 China Canada Brazil Taiwan South Korea Australia India Russia Mexico Hong Kong Singapore Total 0.36% 2.54% 0.42% 0.55% 0.83% 2.05% 0.26% 0.22% 0.29% 0.65% 0.33% 8.49% Market Cap as a % of World Market Cap in 2008 1.72% 3.50% 1.22% 1.03% 1.29% 2.50% 0.62% 0.54% 0.49% 0.84% 0.45% 14.21% Point Change 1.36 0.96 0.81 0.48 0.46 0.45 0.36 0.32 0.20 0.19 0.12 5.72

Countries in Secular Bear Markets
Market Cap as a % of World Market Cap in 2003 U.S. U.K. Italy France Germany Japan Total 52.47% 10.45% 1.56% 3.99% 2.91% 8.64% 80.02% Market Cap as a % of World Market Cap in 2008 45.03% 8.35% 1.54% 4.58% 3.67% 10.60% 73.77% Point Change (7.44) (2.10) (0.02) 0.59 0.76 1.96 (6.25)

For data vendor disclaimers refer to www.ndr.com/vendorinfo. Further distribution prohibited without prior permission. Copyright 2009 (c) Ned Davis Research, Inc. All rights reserved.

9

World Nominal GDP as of 12/31/2003
World Nominal GDP as of 12/31/2003
Secular Bulls 18.0% Secular Bulls 24.2%

World Nominal GDP as of 12/31/2008

18.2% Other Secular Bears 63.8%

Secular Bears

53.3% 22.5% Other

Countries in Secular Bull Markets
GDP as a % of World GDP in 2003 China Russia Brazil India Australia Canada Singapore Hong Kong South Korea Taiwan Mexico Total 4.57% 1.21% 1.55% 1.51% 1.47% 2.41% 0.26% 0.44% 1.78% 0.86% 1.95% 18.00% GDP as a % of World GDP in 2008 7.63% 2.86% 2.76% 1.96% 1.74% 2.61% 0.31% 0.37% 1.64% 0.70% 1.59% 24.16% Point Change 3.06 1.65 1.22 0.45 0.27 0.20 0.06 (0.07) (0.15) (0.17) (0.36) 6.16

Countries in Secular Bear Markets
GDP as a % of World GDP in 2003 U.S. Japan U.K. Germany Italy France Total 30.88% 11.75% 5.17% 6.80% 4.19% 5.01% 63.80% GDP as a % of World GDP in 2008 24.94% 8.49% 4.63% 6.33% 3.99% 4.95% 53.33% Point Change (5.94) (3.26) (0.53) (0.47) (0.20) ( (0.06) ) (10.46)

For data vendor disclaimers refer to www.ndr.com/vendorinfo. Further distribution prohibited without prior permission. Copyright 2009 (c) Ned Davis Research, Inc. All rights reserved.

10

Diminishing Returns from Debt-Financing by Decade
(12/31/1949 - 6/30/2009)
($ in billions)

Debt Range

Diminishing Returns from Debt-Financing by Decade 12/31/1949-6/30/2009 Decade Decade Change in Change in Debt GDP Debt/GDP (billions $) (billions $)

GDP/Debt

12/31/1949-12/31/1959 12/31/1959-12/31/1969 12/31/1969-12/31/1979 12/31/1979-12/31/1989 12/31/1989-12/31/1999 12/31/1999-06/30/2009*
Source: Ned Davis Research. (*) Most recent data available.

337.6 752.1 2,785.2 8,562.8 12,550.0 27,403.6

248.0 491.3 1,654.9 2,922.3 4,026.0 4,543.5

1.36 1.53 1.69 2.93 3.12 6.03

0.73 0.65 0.59 0.34 0.32 0.17

11

The Economy (The Index of Coincident Economic Indicators)
(12-Month Total – $ in billions)
$400 $100 ($200) ($500) ($800) ($1,100) ($1,400) 1965

Budget Surplus Budget Deficit

Federal Government Budget

11/30/2009 = ($1,433.0) ($1 433 0)
1970 1975 1980 1985 1990 1995 2000 2005

2009

8 5 2 (1) (4) (7) (10) 1965

Federal Budget Deficit / Surplus as a % of Nominal GDP

Budget Surplus

2.7

11/30/2009 = -10.0%

Budget Deficit (4.0) (5.7)
1970 1975 1980 1985

(5.4)
1990 1995 2000 2005

2009

Source: Ned Davis Research.

National Bureau of Economic Recessions. 12

Government Debt (Federal, State, and Local) as % of GDP
Quarterly Data 3/31/1952 – 9/30/2009 Q l D 3/31/19 2 106%
100% 94% 88% 82% 76% 70% 64% 58% 52% 46% 1950 1955 1961 1967
53.2% 49.6% 71.0% 83.6% 55-Year Mean = 66.9% 85.6% Government Debt = $14,834.2 billion = 104.0% Gross Domestic Product = $14,266.3 billion

45.1%

47.2%

1973

1979

1985

1991

1997

2003

2009

Data Subject to Revisions by The Federal Reserve Board
Source: Ned Davis Research.

13

Foreign Central Banks
8%
U.S. Nominal Trade-weighted Dollar(1)

120%

6%

100%

% of GDP P

4%

80%

Foreign Official Flows(2) to the U.S.

2%

60%

0%

40%

-2%
19 1 97 0 1 97 1 1 97 2 1 97 3 1 97 4 1 97 5 1 97 6 1 97 7 1 97 8 1 97 9 1 98 0 1 98 0 1 98 2 1 98 3 1 98 4 1 98 5 1 98 6 1 98 7 1 98 8 1 98 9 1 99 0 1 99 1 1 99 2 1 99 3 1 99 4 1 99 5 1 99 6 1 99 7 1 99 8 2 09 9 2 00 0 2 00 1 2 00 2 2 00 3 2 00 4 2 00 5 2 00 6 2 00 7 09
Note: Shaded regions reflect periods of heavy foreign official inflows. (1) Source: J.P. Morgan Chase & Co, BCA Research. (2) Central Banks and Monetary Authorities.

20%

14

Dollar Watch – Two Foreign Holders of U.S. Treasury Securities
($ in billions)
$900 $800 $700 $600 $500 $400 $300 $200 $100 $0 2001 2001 2002 2003 2004 2005 2006 2007 2007 2008 2009 Treasury Holdings as of 9/30/2009

$798.9

$185.3

China

OPEC

Source: Ned Davis Research.

15

The United States Economy

Good News
History Suggests +4% Recovery Is Conservative
Real GDP Peak-toFirst year Trough Decline Recovery
Increa in Real GDP During ase D First Year of Recover (%) t ry

9 8 7 6 5 4 3 2 1 0 0 -1 -2

Recession 1957 1973 Deep 1981 2009 Shallow 2001

1953

1982

2008

-3.7% -3.1% -2.9% -3.9% -0.3%

+6.9% +6.1% +8.5% +8.6%e +1.9%

1960 1974

1957

1970 2001

1990
Regression Y = 2.2 + 1.7*X R2 = 64%

-3

-4

-5

Decline in Real GDP During Recession (%)

Source: ISI Group.

17

Good News
By Component, It’s Not Hard to Get +4 0% Real GDP Component It s +4.0%
2010:4Q Real GDP Cont. to GDP 4Q / 4Q Consumer Spending CapEx Eqp Housing Inventories Trade Federal Government State G St t Government t CapEx Structures Real GDP
Source: ISI Group.

+1.0% +10.0% +10.0% +$196.0 +$140.0 +6.0% -1.0% 1 0% -10.0%

0.7% 1.0% 0.2% 1.5% 1.0% 0.4% -0.1% 0 1% -0.5% 4.2% 4 2%

18

Bad News
Recovery Off to a Slow Start
Real GDP Q/Q % A.R. 1 and 2nd Quarter of Recovery 2nd 1st
st

1975 1983 1991 2002 2009

+3.1% +5.1% +2.7% +3.5% +2.8% r

+6.9% +9.3% +1.7% +2.1% +3.0%e

Source: ISI Group. r = expected revision

19

Not a Normal Cycle
Real Retail Sales )(YoY) (
15% 10% 5% 0% -5% -10% -36 -28 -20 -12 -4 4 12 20 28 36 44 52 60 Typical Cycle This Cycle 1 StDev 160 140 120 100 80 60 40 20 -36 -28 -20 -12 -4 4 12 20 28 36 44 52 60 `

Consumer Confidence (Conf) Board) (
Typical Cycle This Cycle 1 StDev

S&P 500 (In)
Typical Cycle 80% 60% 40% 20% 0% -20% -40% -60% -80% -36 -28 -20 Source: Bridgewater -12 -4 4 12 20 28 36 44 52 60 This Cycle 1 StDev 15% 10% 5% 0% -5% -10% -15% -20% -36 -28

Real Home Price Inflation
(Home Prices YoY – CPI YoY)
Typical Cycle This Cycle 1 StDev

-20

-12

-4

4

12

20

28

36

44

52

60

20

Good News
Lift to GDP from Spending Part of Stimulus
($ in billions)
$300

Funds Distribution Reported By Week
(Total Stimulus Amount – $787 Billion)
Sep 30, 2010 $255 e

$250 $200

$150 $100

Paid Out Nov 6 $132.5 b

$50 $0 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10

Source: ISI Group.

21

Good News
Inventories Still Plunging
U.S. Real Inventory Change
2009: 3Q -$130.8
$150 $100 $50 $0 ($ ) ($50) ($100) ( ($150) ) ($200) 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

2009

Source: ISI Group.

22

CapEx – Help for Industrial Machinery Shares
U.S. Nominal CapEx Eqp Ex Tech
Q/Q % Ch A.R. 2009:3Q: - 10.0%
30

20

10

0

-10

20 -20

-30

-40 40

-50

-60 1Q 2003

1Q 2004

1Q 2005

1Q 2006

1Q 2007

1Q 2008

1Q 2009

Source: ISI Group. 23

U.S. Employment
Unusually Large Job Cuts Relative to GDP
-5.0% -4.5% Peak-t to-trough De ecline In Employmen nt -4.0% 3.5% -3.5% -3.0% -2.5% -2.0% -1.5% -1.0% 1 0% -0.5% 0.0% 0.0%
Source: ISI Group.

2008 Actual

1957 1953 2008 Fitted 1982 1974 2001 1960 1990 1970 Regression Y = -0.9 + 0 7*X 0 9 0.7 X 2 R = 73%

-0.5%

-1.0% -1.5% -2.0% -2.5% -3.0% Peak-to-trough Decline in Real GDP

-3.5%

-4.0%
24

U.S. Employment
Likely to Increase Soon
U.S. Temp Employment
M/M Ch 3 Mo. Avg. Nov 38
60 40 20 0 -20 -40 -60 -80 -100 1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: ISI Group. 25

U.S. Employment
Likely to Increase Soon
Total Work Week
35.0

Nov 33.2

34.5

34.0

33.5

33.0 1988

1989

1991

1993

1994

1996

1998

1999

2001

2003

2004

2006

2008

2009

Source: ISI Group. 26

U.S. Profits
Another Blowout Quarter for Productivity
U.S. Productivity
2 Qtr. % Ch. A.R. 2009:3Q 8.2%
10 8 6 4 2 0 -2 -4 -6 1Q 1980 1Q 1982 1Q 1984 1Q 1986 1Q 1988 1Q 1990 1Q 1992 1Q 1994 1Q 1996 1Q 1998 1Q 2000 1Q 2002 1Q 2004 1Q 2006 1Q 2008

Biggest Gain in almost Five Decades

Source: ISI Group. 27

Increased Household Savings Reduces Spending
— U S Personal Savings Rate — U S Household Net Worth % Disposable Income U.S. U.S.
14% 700%

12%

650%

10%

600%

8%

550%

6%

500%

4%

450%

2%

400%

0%

350%

-2% 60 64 68 72 76 80 84 88 92 96 00 04 08

300%

Source: Bridgewater

28

U.S. Consumer
CID Down a Record Amount Over the Past Six Months
U.S. Consumer Installment Debt
8 Mo. % Ch. A.R. Sep -6.3%
25%

20%

15%

10%

5%

0%

-5%

-10% 1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Source: ISI Group. 29

Housing
Inventory of New Houses for Sale at a 38-Year Low
U.S. New Houses for Sale
0.60 0.55 0.50 0.45 0.40 0.35 0.30 0.25 0.20 1988 1990 1993 1996

Oct 0.239

1998

2001

2004

2007

U.S. Existing Houses For Sale
4.0 3.5 3.0 2.5 2.0 1.5 1988
Source: ISI Group. 30

Oct 2.97

1990

1993

1996

1998

2001

2004

2007

Housing
Prices Increasing
U.S. House Price Index (Case-Shiller)
SA M/M % Sep 0.3%
2.0% 2 0% 1.5% 1.0% 0.5% 0.0% 0 5% -0.5% -1.0% -1.5% -2.0% -2.5% 2005 2006 2007 2008 2009

Source: ISI Group. 31

U.S. Manufacturing
Exports Increasing Significantly
U.S. Mfg PMI Export Orders
3 Mo. Avg.
65% 60% 55% 50% 45% 40% 35% 2000 2001 2002 2004 2005 2006 2008 2009
Latest Click 56.0%

Nov: 55.5%

U.S. U S Real Goods Exports
3 Mo. Avg.
30% 10% -10% -30% -50% 2000
Source: ISI Group.

3 Mo. % A.R.

Sep: 25.0%

2001

2002

2004

2005

2006

2008

2009

32

U.S. Manufacturing
Nov IP Probably +0.6% M/M +0 6%
U.S. Industrial Production
5 Mo. % A.R.
20 15 10 5 0 -5 -10 -15 -20 -25 1970

Nov 8.8% e

1975

1980

1985

1990

1995

2000

2005

2009

Source: ISI Group.

33

Small Business Not Hiring

U.S. Small Business Trends (NFIB)
Job Openings
35% 30% 25%
Latest Click 8.0%

3 Mo. Avg. Mo Avg

Nov 8.0% 8 0%

20% 15% 10% 5% 1988

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

Source: ISI Group.

34

Good News
Monetary Base Increasing at a +84 2% Annual Rate +84.2%
U.S. Monetary Base
Nov 4 $ 1,999.8
$2,200 $2,000 $1,800 $1 800 $1,600 $1,400 $1 400 $1,200 $ , $1,000 $800 Jan 07

Jun 07

Nov 07

Apr 08

Sep 08

Feb 09

Jul 09

Dec 09

Source: ISI Group.

35

Good News
Money Moving Into Riskier Investments
Junk Bond Yields (Merrill Lynch)
Nov 13 9.82% 9 82%
24% 22% 20% 18% 16% 14% 12% 10% 8% 6% 2006

2007

2008

2009

Source: ISI Group.

36

U.S. Profits
Profits-Led Recovery
ISI Global Economic Diffusion Index
13 Wk. Avg.
15 5 -5 -15 -25 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Dec 7

11.7

First Call Earnings Revisions Up
SA by ISI
60 50 40 30 20 1998
Source: ISI Group.

13 Wk. Avg.

Nov 27

62.5%

1999

2000

2001

2002

2003

2005

2006

2007

2008

2009
37

U.S. Inflation
Inflation Watch
U.S. Average Hourly Earnings
Y/Y %
5% 4% 3% 2% 1% 0% 1998 1999 2001 2003 2005 2007 2009

U.S. CPI Core
Y/Y %
3.0% 2.5% 2.0% 1.5% 1.0% 1998

Oct 2.4%

Sep 1.5%

1999

2001

2003

2005

2007

2009

U.S. CPI Total Rent
Rent plus Owners’ Equivalent Rent Y/Y % Sep 1.4%
5% 4% 3% 2% 1% 1998
Source: ISI Group.

1999

2001

2003

2005

2007

2009
38

The Rest of the World

Conditions Have Diverged
Industrial Production Index
— U.S.A.
105 100 95 90 85 80 75 70 65 60 00 02 04 06 08 10 105 100 95 90 85 80 75 70 65 60 00 02 04 06 08 10

— Europe
105 100 95 90 85 80 75 70 65 60 00 02

— Japan

04

06

08

10

— Chi China
120 110 100 90 80 70 60 50 40 30 00 02 04 06 08 10 60 50 00 80 70 100 90 110

—E Emerging Markets i M k t
105 100 95 90 85 80 75 70 65 60 02 04 06 08 10 00

— EM ex-China Chi

02

04

06

08

10

Source: Bridgewater.

40

Japan Real Exports
Nominal GDP Likely to Remain Weak

Japan Real Exports
Real GDP 2009 1Q 2Q 3Q -12.2% +2.7% +4.8% Q/Q % A.R. Price Nominal Deflator GDP +2.4% -4.2% -4.8% -10.1% -1.6% -0.3%
2009 3Q: 69.4
100 95 90 85 80 75 70 65 60
2006 1/0/00 2007 1/4/00 2008 1/8/00 2009 1/12/00

+13.2%
1/16/00

Source: ISI Group.

41

Japan
Government and Corporate Debt % GDP Much Higher than in the U.S. US
250% 200% 150%

300% 250% 200% 150% 100% 50% 0% 1985 1990 1994 1999 2004 2009 1980 1985 1990 1994 1999 2004 2009

100% 50% 0% 1980

JAPAN GOVT DEBT % GDP 2009:2Q: 204.4%

U.S. GOVT DEBT % GDP 2009:2Q: 67.0%

JAPAN NONFIN CORPORATE DEBT % GDP Debt Securities and Loans 2009:2Q: 178.3%

U.S. NONFIN DEBT % GDP 2009:2Q: 77.3%

105% 95% 85% 75% 65% 55% 45% 1980 1985 1990 1994 1999 2004 2009

500% 400% 300% 200% 100% 0% 1980 1985 1990 1994 1999 2004 2009

JAPAN CONSUMER DEBT % GDP 2009:2Q: 78.6%

U.S. CONSUMER DEBT % GDP 2009:2Q: 96.5%

JAPAN NONFIN TOTAL DEBT % GDP 2009:2Q: 461.3%

U.S. TOTAL DEBT % GDP 2009:2Q: 242.5%

Source: ISI Group.

42

Severe Underperformance From Japanese Equities
Japan MSCI Index Relative To World MSCI Index
3.2 3.0 2.8 2.6 26 2.4 2.2 2.0 1.8 1.6 1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: BCA Research 2009.

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The 20th Century was a Growth Anomaly For China
% of World GDP
35%

30%

25%

20%

15%

10%

5%

0% 1 1000 1500 1600 1700 1820 1870 1900 1913 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2003

Source: Historical Statistics for the World Economy – Angus Maddison, J.P. Morgan Securities, Inc. 44

China
Another Package of Strong China Data

China Exports
S.A. by ISI, Oct 725.8
900 850 800 750 700 650 600 550 2007 2008 2009
+34.9% Annual Rate

China Imports
S.A. by ISI, Oct 622.6
800 750 700 650 600 550 500 450 400 2007 2008 2009
+36.2% Annual Rate

Source: ISI Group.

45

India
GDP Set to Reaccelerate

12 10 8 6 4 2 0 1999 2000 2001 2002

India Real GDP Y/Y%
Forecast 2010:3Q 8.3% 2010 3Q 8 3%

2009:2Q 6.2%

2003

2004

2005

2006

2007

2008

2009

2010

Source: ISI Group.

46

Brazil
GDP Set to Reaccelerate

8 6 4 2 0 -2 1997

Brazil Real GDP Y/Y%

Forecast 2010:1Q 6.9%

2009:1Q -1.4%

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Source: ISI Group.

47

Some Thoughts About the Price of Oil

Long-Term Demand Drivers Are Still in Place
Petroleum Consumption per Capita for Selected Countries
31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 13 3 12 11 10 9 8 7 6 5 4 3 2 1 0

In Barrels per Person per Year

Yearly Data 12/31/1960 - 12/31/2007

Country United States Japan Russia Brazil China India

Consumption Per Capita 25.1 25 1 14.3 7.5 4.5 2.1 0.9

Year 2007 2007 2007 2007 2007 2007

31 30 29 28 27 26 25 24 23 22 21 20 19 18 17 16 15 14 3 13 12 11 10 9 8 7 6 5 4 3 2 1 0

Sources: Energy Information Administration and U.S. Census Bureau. Ned Davis Research.

1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

49

Oil Supply / Demand Prospects
World P i W ld Primary Energy Demand E D d
6,000 Peak Oil: 2015 5,000 5 000 Peak Oil: 2010 4,000 Oil Coal Gas Biomass Nuclear Other Renewables Mtoe e

3,000

2,000

1,000

0 1980 1990 2000 2010 2020 2030

World energy demand expands by 45% between now and 2030 – an average rate of increase of 1.6% per year – with coal accounting for more than a third of the overall rise
Source: IEA World Energy Outlook 2008. Bank of America Merrill Lynch.

50

Oil Supply / Demand Prospects
BRIC and Middl E t D d Middle East Demand O tl k d Outlook
(in Mmbl/d)

2008 Demand Brazil Russia India China Middle East Total 2.4 2.9 3.1 7.9 5.9 22.2

2030E Demand 3.6 3.9 7.3 17.0 10.0 41.8

Increase +1.2 +1.0 +4.2 +9.1 +4.1 +19.6

Conclusions: (1) Competition for oil supplies between emerging markets and mature countries is potentially a problem (2) The world needs and will actively seek out demand “Game Changers”
Source: IEA World Energy Outlook 2008. Bank of America Merrill Lynch.

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Disclaimer
The views expressed in this commentary are the personal views of Byron Wien of Blackstone Advisory Services L.P. p y p y y (together with its affiliates, “Blackstone”) and do not necessarily reflect the views of Blackstone itself. The views expressed reflect the current views of Mr. Wien as of the date hereof and neither Mr. Wien nor Blackstone undertakes to advise you of any changes in the views expressed herein. Blackstone and others associated with it may have positions in and effect transactions in securities of companies mentioned or indirectly referenced in this commentary and may also perform or seek to perform investment banking y y y g services for those companies. Blackstone and/or its employees have or may have a long or short position or holding in the securities, options on securities, or other related investments of those companies. Investment concepts mentioned in this commentary may be unsuitable for investors depending on their specific investment objectives and financial position. Where a referenced investment is denominated in a currency other than the investor's currency, changes in rates of exchange may have an adverse effect on the value or price of or income derived from the investment. Tax considerations, margin requirements, commissions and other transaction costs may significantly affect the economic consequences of any transaction concepts referenced in this commentary and should be reviewed carefully with one's investment and tax advisors. Certain assumptions may have been made in this commentary as a basis for any indicated returns. No representation is made that any indicated returns will be achieved. Differing facts from the assumptions may have a material impact on any indicated returns. Past performance is not necessarily indicative of future performance. The price or value of investments to which this commentary relates, directly or indirectly, may rise or fall. This commentary does not constitute an offer to sell any security or the solicitation of an offer to purchase any security. To recipients in the United Kingdom: this commentary has been issued by Blackstone Advisory Services L.P. and approved by The Blackstone Group International Limited, which is authorized and regulated by the Financial Services Authority. The Blackstone Group International Limited and/or its affiliates may be providing or may have provided significant advice or investment services, including investment banking services, for any company mentioned or indirectly referenced in this commentary. The investment concepts referenced in this commentary may be unsuitable for investors depending on their specific investment objectives and financial position. This commentary is disseminated in Japan by The Blackstone Group Japan KK and in Hong Kong by The Blackstone Group (HK) Limited.
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