Market Strategy

March 18, 2011

Investment Strategy Outlook

Please refer to Appendix – Important Disclosures.

Focus On Risk Management Outlook Summary

Marketweight Exposure to Stocks,
Highlights: Underweight Bonds
 Dollar Loses Favor as Safety Trade
Secular Risks Unabated
 Inflation Outlook Remains Benign
 Economic Growth Improving Aging Cyclical Bull Retains Benefit of the
 Investors Turning Cautious Doubt
 Breadth Indicators to Be Tested
S&P 500 Support Near 1225;
With the stock market having now experienced its first 5% correction Resistance Near 1300
since last August (nearly three times the average length between such
pullbacks), the question of the persistence of cyclical bull market is Mid-caps, Energy and Industrials in the
again arising. While secular risks remain high (one need only scan Lead
the headlines for at least a handful of realized and potential
trouble spots), the weight of evidence remains bullish and the
rally, now entering its third year looks to be intact. The strength of the rally will be evident on any rebound once
the current pullback runs its course. A failure of index gains to be matched by broad market participation (and
confirmation) would represent an important change in character of the rally and could suggest that upside potential in
the indexes is limited. While the weight of the evidence is bullish, the secular environment is such that investors
should focus on risk management, and not be unduly focused on chasing returns.
Risk management can have
S&P 500 (.SPX)
165
two components: decisions
160
about where to invest, and
155
the duration of that
150
investment decision. These
145

140
are the essential aspects of a
135
tactical strategy. As opposed
130
to a traditional buy-and-hold
125
approach, tactical strategies
120 identify periods of higher risk
115 and lower risk and allow
110 portfolio allocations to
105 fluctuate. This can mean
100 tilting toward higher beta
95
areas of the market during
90
rallies, and increasing cash
85
positions and/or tilting toward
80
lower beta areas of the
75
market during periods of
70

65
weakness or uncertainty.
Created in MetaStock from Equis International 10 and 40-Week Moving Averages
60
While average equity
x10
J J A S O N D 2007 A M J J A S O N D 2008 M A M J J A S O N D 2009 M A M J J A S O N D 2010 A M J J A S O N D 2011 A M J exposure over time may not
vary between a static buy-

Bruce Bittles William Delwiche, CMT, CFA

Chief Investment Strategist Investment Strategist
bbittles@rwbaird.com wdelwiche@rwbaird.com
615.341.7114 414.298.7802
10R.17
Market Strategy
March 18, 2011

and-hold approach and dynamic

tactical approach, asset
preservation in periods of stress
(i.e., effective risk management)
can help boost portfolio returns
during rallies.
At a basic level, tactical
investing can be thought of as
shifting between cash (a safe
investment) and stocks (risky
investments). This calculus
appears to be undergoing
something of a transition as
cash, which for domestic
investors has usually meant the
U.S. dollar, appears to be losing
some of its global stature. The
dollar remains, for now, the
dominant global currency, but at
the margin, demand is
weakening and investors are
looking elsewhere. We have
discussed this in the past as it the cascading tragedies in the Japan has been the
relates to gold, which seems to have moved from a relative weakness of the U.S. dollar. Past periods of
participant in the commodity markets to a participant in global uncertainty have usually been accompanied by
the currency markets as investors have shunned paper strength in the dollar – investors have sought the safety
currencies generally in favor of hard assets. Now, of that currency until the dust settles and the global view
however, the dollar appears no longer to be the becomes more certain. Now, we are seeing the dollar
preferred “flight to safety” vehicle even among paper make new cyclical lows and investors are seeking safety
currencies. From the point of view of the financial in other currencies, notably the Swiss Franc and the
markets, one of the most intriguing developments Japanese Yen. Remarkably, the yen surged in the week
seen amidst the recent turmoil in the Mid East and following the Japanese earthquake/tsunami even as the
Bank of Japan injected trillions
of yen into the market.
What then is behind the
weakness in the U.S. dollar? In
the short-to-intermediate term,
foreign central banks have been
buying fewer U.S. Treasury
Notes and more actively
hedging their current exposure
to U.S. Treasuries by
diversifying their currency
holdings. They have increased
their holdings in gold as well as
other currencies. Over the
longer term, investors may
well be seeing the structural
budget deficits of the U.S.
Federal government and
concluding that the supply of
dollars in circulation will have
to increase to meet these
expected liabilities.

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Our view is that this is best

viewed as a currency issue,
not an inflation issue. While
an excess supply of dollars in
the domestic economy is a
prerequisite for inflation, it is not
sufficient for inflation. To get
sustainable increases in the
price level, wage growth would
have to accelerate. We have no
evidence that this is currently
occurring, especially with the
considerable slack still in the
labor market. Moreover, even
with the foreign buyers paring
back their Treasury purchases,
bond yields have remained
relatively low, with the yield on
the benchmark 10-year T-Note
ranging between 3.25% and
3.75%. With the U.S. economy
still debt-based (progress has
been made in this regard, but it manifested as higher commodity prices (items priced in
remains slow and uneven), higher yields right now are dollars will see their prices go up if the dollar goes
unsustainable as it would make servicing the debt more down). The domestic economic impact, all else being
cumbersome. Higher inflation expectations that filter equal, will be similar to a tax on consumers and tighter
into bond yields would likely result in a slowing in profit margins for corporations (to the extent they are
economic growth – stemming demand and raising unable to pass prices through to consumers). In the
again the specter of deflation (which we continue to current environment, higher commodity costs are
view as a more substantial long-term threat than more likely to be impediments to growth than
inflation). catalysts for inflation.
As a currency issue, the excess supply of dollars is Tactical investors may want to expand their decision tree
to include gold along with stocks
and cash as they are making
investment decisions. More
Indicator Review sophisticated investors may
even look for opportunities to
gain exposure to foreign
Fundamental Factors currencies that are assuming
Federal Reserve Policy Bullish +1 the role once played by the U.S.
dollar.
Underlying Economic Fundamentals Neutral 0
Secular headwinds notwith-
Valuations Neutral 0 standing, our review of the
Technical Factors indicators suggests that the
benefit of the doubt remains
Investor Sentiment Neutral 0 with the bulls. The Federal
Trends/Seasonal Tendencies Bullish +1 Reserve is still bullish, seasonal
patterns/trends are supportive,
Tape/Breadth Bullish +1 and the broad market has yet to
---------------------------------- ----------- ----- show the kind of divergences
that typically precede a
Weight of the Evidence Bullish +3 significant market top.
Sentiment indicators have
shown more pessimism and

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March 18, 2011

skepticism among investors,

although these results remain
preliminary. In several ways,
the March correction places a
burden on the bulls. A quick
return to optimism and/or a
failure for the broad market to
improve with the indexes on
any rallies would suggest that
the final chapters of the cyclical
rally that just celebrated its
second anniversary are being
written.
Federal Reserve policy:
Bullish. In its latest statement
the Fed acknowledged the
recent rise in commodity prices
and the upward movement in
inflation expectations. However,
it continues to expect inflation
trends to remain subdued. This
is in line with our view that any
near-term whiffs of inflation expectation is that growth will slow, and the fourth
would likely not be sustainable given the debt situation quarter of the year may bring increased chatter about
and the excess capacity in the labor market. Even with QEIII.
improving economic data, the Fed will likely complete its
Economic Fundamentals: Neutral. Near-term growth
planned asset purchases ($600 billion of longer-term
is improving, although trouble spots remain. The
Treasury securities) announced last fall as the second
unemployment rate has come down considerably in
round of quantitative easing (QEII). These purchases
recent months (from 9.8% in November to 8.9% in
should be completed by mid-year, and the wild card is
March). Weekly initial jobless claims are in a down-trend
what happens to bond yields and economic growth as
as the pace of layoffs slows. Payroll growth has been
the Federal Reserve’s support is removed. Our
uneven and well below
historical trends, but the pattern
has now turned positive.
Regional and national
manufacturing surveys shows
that business activity remains
robust, and one of the upsides
to a weaker dollar is increased
demand for exports. The
housing market remains a
primary area of concern, and
the sharp drop in residential
construction activity in February
(largely undoing the surge seen
in January) is not encouraging.
The uncertainty surrounding
Japan could put strains on
global growth in the near term,
both from a lack of demand as
well as potential supply
disruptions. While the Japanese
economy is not dynamic in
terms of growth, it is still the

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March 18, 2011

third-largest economy in the

world. It is too early to be able
to fully assess the economic
impact of the recent events in
that country, but our best guess
right now is that it modestly
dampens global growth for a
quarter or two, before rebuilding
efforts begin in earnest. This
assumes a satisfactory
resolution to the breakdowns
seen at the nuclear power
plants.
Valuations: Neutral. Stocks
are not cheap, nor are they
expensive. The price/earnings
ratio, based on trailing actual
earnings for the median
company in the S&P 500 is little
changed from a month ago and
is near its long-term average.
Our most important take away
from the valuation indicators is that there is little CBOE put/call ratio over 100%), a surge in the VIX fear
evidence that a secular page has been turned. We index to its highest level since July, and shifts in the
continue to view the rally as cyclical in nature, and within weekly surveys from bulls to bears. The latest data from
the context of a longer-term secular bear market. the AAII shows the most bears and fewest bulls since
late last summer (when stocks were undergoing that last
Investor Sentiment: Neutral. The March sell-off has
correction of at least 5%), and the NAAIM survey of
been accompanied by more skepticism and pessimism,
active investment managers showed that in the second
although optimism has not sufficiently waned to suggest
week of March, average equity exposure for these
that investor sentiment has turned bullish. We have seen
managers dropped from 75% to 41%, with the
increased demand for protective puts (pushing the
distribution shifting significantly toward the bears.
Optimistic managers kept their
equity exposure elevated. This
lingering bullishness can also
be seen in the Investors
Intelligence data, which
continues to show more than
twice as many bulls as bears
(this survey tends to move more
slowly, so reversals could be
upcoming, which would make
the overall sentiment picture
more bullish).
Seasonal Patterns/Trends:
Bullish. The composite
seasonal pattern, which
aggregates the 1-year, 4-year
(Presidential) and 10-year
cycle, suggests stocks could
make a significant peak in the
third quarter of this year. With
the last round of Federal
Reserve intervention due to be
wrapped up by the end of June,

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Market Strategy
March 18, 2011

we could see this peak prior to

what the cycle anticipates
(perhaps in the second
quarter). While this provides a
road map of sorts, we must
respond to the signals being
given by the market. The short-
term trend and momentum
indicators have weakened
during the March sell-off. The
longer-term trends remain
strong. All 30 of the primary and
secondary domestic market
indexes we track have seen
their 50-day averages remain
above their 200-day averages.
At this point, pullback has
relieved widespread
overbought conditions rather
than doing significant
damage to the trends. There
is a fine line between the two,
but we do not believe we have
crossed it. On a relative basis the trends for large-caps and their underlying breadth measures on any rallies
look more favorable than those for small-caps, while the that emerge would suggest a significant weakening
trend in the S&P 500 is more favorable than the trend in in the health of the bull market. We will be watching
the NASDAQ Composite. These conditions are more two sets of breadth indicators in particular: the
typical of the later stages of cyclical rallies than the early percentage of industry groups in uptrends and the
stages. advance/decline lines for the S&P 500, 400, and 600.
Divergences between the advance/decline lines and
Broad Market: Bullish. The broad market indicators their respective indexes, or divergences among the
remain bullish, although the true test of their resiliency advance/decline lines would represent a change in
will be forthcoming. Divergences between the indexes character. Likewise, an inability
of any index rally to draw broad
support at the industry group
level will be viewed as suspect.
Right now the breadth
indicators remain strong, as
they peaked in line with the
indexes. Ensuing rallies may
provide clues for how much
further this cyclical bull market
can run.

Robert W. Baird & Co. Page 6

Market Strategy
March 18, 2011

BAIRD STRATEGIC ASSET ALLOCATION MODEL PORTFOLIOS

Baird offers six strategic asset allocation model portfolios for consideration (see table below), four of which have a mix of equity and
fixed income. An individual’s personal situation, preferences and objectives may suggest an allocation more suitable than those shown
below. Please consult a Baird Financial Advisor in determining an asset allocation that will meet your needs.

Mix: Stocks /
Model Portfolio Risk Tolerance Strategic Asset Allocation Model Summary
(Bonds + Cash)
Emphasis on providing aggressive growth of capital with high
All Growth 100 / 0 Well above average fluctuations in the annual returns and overall market value of the
portfolio.
Emphasis on providing growth of capital with moderately high
Capital Growth 80 / 20 Above average fluctuations in the annual returns and overall market value of the
portfolio.
Emphasis on providing moderate growth of capital and some current
Growth with
60 / 40 Average income with moderate fluctuations in annual returns and overall
Income
market value of the portfolio.
Emphasis on providing high current income and some growth of
Income with
40 / 60 Below average capital with moderate fluctuations in the annual returns and overall
Growth
market value of the portfolio.
Emphasis on providing high current income with relatively small
Conservative
20 / 80 Well below average fluctuations in the annual returns and overall market value of the
Income
portfolio.
Emphasis on preserving capital while generating current income with
Capital
0 / 100 Well below average relatively small fluctuations in the annual returns and overall market
Preservation
value of the portfolio.

Baird’s Investment Policy Committee offers a view of potential tactical allocations amongst equity, fixed income and cash, based upon a
consideration of U.S. Federal Reserve policy, underlying U.S. economic fundamentals, investor sentiment, valuations, seasonal trends,
and broad market trends. As conditions change, the Investment Policy Committee adjusts the weightings. The table below shows both
the normal range and current recommended allocation to stocks, bonds and cash. Please consult a Baird Financial Advisor in
determining if an adjustment to your strategic asset allocation is appropriate in your situation.

Asset Class / Growth with Income with Conservative Capital

All Growth Capital Growth
Model Portfolio Income Growth Income Preservation
Equities:
Suggested allocation 95% 80% 60% 40% 20% 0%
Normal range 90 – 100% 70 - 90% 50 - 70% 30 - 50% 10 - 30% 0%
Fixed Income:
Suggested allocation 0% 10% 30% 40% 45% 60%
Normal range 0 - 0% 10 - 30% 30 - 50% 40 - 60% 45 - 65% 55 – 85%
Cash:
Suggested allocation 5% 10% 10% 20% 35% 40%
Normal range 0 - 10% 0 - 20% 0 - 20% 10 - 30% 25 - 45% 15 - 45%

ROBERT W. BAIRD’S INVESTMENT POLICY COMMITTEE

Bruce A. Bittles William A. Delwiche, CMT, CFA Timothy M. Steffen, CPA, CFP®
Managing Director First Vice President Senior Vice President
Chief Investment Strategist Investment Strategist Financial-Estate Planning Manager
Timothy P. Byrne, CFA Todd K. Parrish Laura K. Thurow, CFA
Managing Director Senior Vice President Senior Vice President
Director of PWM Research, Prod & Svcs PWM – Equity Analyst Co-Director of PWM Research
Patrick J. Cronin, CFA, CAIA Warren D. Pierson, CFA Robert J. Venable, CFA
Senior Vice President Managing Director Managing Director
Institutional Consulting Baird Advisors Co-Head Global Equities

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March 18, 2011

Appendix – Important Disclosures

Disclaimers

This is not a complete analysis of every material fact regarding any company, industry or security. The opinions
expressed here reflect our judgment at this date and are subject to change. The information has been obtained from
sources we consider to be reliable, but we cannot guarantee the accuracy.

Foreign and emerging market securities may be exposed to additional risks including currency fluctuation, political
instability, foreign taxes and regulations and the potential for illiquid markets. Historically, small and mid cap stocks have
carried greater risk and have been more volatile than stocks of larger, more established companies.

ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST.

The Dow Jones Industrial Average, S&P 500, S&P 400, MSCI EAFE, Lehman U.S. Aggregate Benchmark, Lehman
Municipal Bond Benchmark, Russell 1000, Russell Mid Cap, Russell 2000, and Russell 3000 are unmanaged common
stock indices used to measure and report performance of various sectors of the stock market; direct investment in indices
is not available.

Baird is exempt from the requirement to hold an Australian financial services license. Baird is regulated by the United
States Securities and Exchange Commission, FINRA, and various other self-regulatory organizations and those laws and
regulations may differ from Australian laws. This report has been prepared in accordance with the laws and regulations
governing United States broker-dealers and not Australian laws.

Copyright 2011 Robert W. Baird & Co. Incorporated.

Other Disclosures

UK disclosure requirements for the purpose of distributing this research into the UK and other countries for
which Robert W Baird Limited holds an ISD passport.

This report is for distribution into the United Kingdom only to persons who fall within Article 19 or Article 49(2) of the
Financial Services and Markets Act 2000 (financial promotion) order 2001 being persons who are investment
professionals and may not be distributed to private clients. Issued in the United Kingdom by Robert W Baird Limited,
which has offices at Mint House 77 Mansell Street, London, E1 8AF, and is a company authorized and regulated by the
Financial Services Authority. For the purposes of the Financial Services Authority requirements, this investment research
report is classified as objective.

Robert W Baird Limited ("RWBL") is exempt from the requirement to hold an Australian financial services license. RWBL
is regulated by the Financial Services Authority ("FSA") under UK laws and those laws may differ from Australian laws.
This document has been prepared in accordance with FSA requirements and not Australian laws.

Robert W. Baird & Co. Page 8