1011 blackrock fi slides - qe2 overview

8/6/2019 1011 Blackrock FI Slides - QE2 Overview

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Fixed Income Monthly Markets Call:Finally QE2 is Here. It Will Help, But Not By

Itself, and It Isnt Without Downside.

FOR FINANCIAL PROFESSIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

Rick RiederChief Investment Officer of Fixed Income, Fundamental PortfoliosBlackRock

The opinions expressed are as of 4 November 2010 and may change as subsequent conditions vary.


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2FOR FINANCIAL PROFESSIONAL USE ONLY NOT FOR PUBLIC DISTRIBUTION

Date: November 4, 2010

Time: 8:00am Eastern Standard Time*

Conf. Call Name: Monthly Markets Call

Passcode: 5952492

U.S. Dial-in #: 888-551-9020

International Dial-in #: 719-325-2431

Replay Information: U.S. Dial-In #: 888-203-1112

International Dial-In #: 719-457-0820

Passcode:5952492

*Due to potentially high call volume, we recommend dialing in 15 minutes before the start of the call.

Dial-in Information


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We have been describing for three months now how the largest (only?) factor influencing markets ispolicy, and exclusively monetary policy

One line in the Feds recent statement foreshadowed future monetary policy and presented a rather significant call to the capital markets

The Two (or Four) Big Letters Q.E. (or Large Scale Asset Purchases)

Prepared to provide additional accommodation if needed to support theeconomic recovery and to return inflationto levels consistent with itsmandate.

Source: Federal Reserve

FOMC Statement: 21 September 2010

and now

To promote a stronger pace of economic recovery and to help ensure thatinflation, over time, is at levels consistent with its mandate, the Committeedecided today to expand its holdings of securitiesThe Committee intends

to purchase a further $600 billion of longer-term Treasury securities by theend of the second quarter of 2011, a pace of about $75 billion per month.

Is it possible that the Fed has decided that lifting assets is the appropriate road to raising inflationexpectations? And, have they decided that focusing on inflation expectations is the path towardsultimately creating higher levels of employment and that monetary policy tools today are too blunt to

effectively lower unemployment?

FOMC Statement: 3 November 2010


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1,040

1,060

1,080

1,100

1,120

1,1401,160

1,180

1,200

25- Aug 1 -Sep 8-Sep 15-Sep 22-Se p 29-Se p 6-Oct 13- Oct 20 -Oct 2 7-Oct

10

12

14

16

18

20

22

24

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Jan Feb Mar A pr May Jun Jul Aug Sep Oct Nov Dec

Source: Bloomberg; Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index.

VIX Index: 1990-2009 Average Monthly Level

The S&P 500 returned 8.76% in September, its 2nd best September performance since 1928, alongside economic data whichwas merely decent and then tacked on another 3.8% in OctoberAs suggested last month, a strong September equity market performance is typically followed by a strong 4 th quarter.

Anticipated Policy Helping Risk Assets in What is Normally a Weak Month for Equities?

SPX Index

SPX Index: 1990-2009 Average Monthly Return


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-6,000,000

-5,000,000

-4,000,000

-3,000,000

-2,000,000

-1,000,000

0

1,000,000

2,000,000

3,000,000

4,000,000

1977 1980 1983 1986 1989 1992 1995 1998 2001 2004

Startup Job Creation Net Job Creation For Exis ting Firms

0

50

100

150

200

250

300

350

Jan Feb Mar Apr May Jun Jul Aug Sep

Why Policy is Needed (and Why it is a Long Road)

Job creation is not happening rapidly enough to keep unemployment rates at breakeven levelsPolicy HAS toaddress this... The economy/jobs wont improve fast enough organically

Source: Bloomberg, Bank of America, The Kauffman Foundation

MoM Change in Private Payroll Data (thousands) Job Creation With & Without Start-ups

Normal Recovery

Unemployment Breakeven


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Source: Bureau of Labor Statistics, Federal Reserve

We have been highlighting how there is a structural softness to the economy, which we expect will be in place for a whileHiring is not expected to come back to prior levels for a long time, and the potential for a traditionally strong reboundfollowing a swift and deep downturn has greatly diminished

IT CapEx as a % of Total Fixed InvestmentRevenue and EBITDA per Employee Projected(S&P500 ex-Financials)

Sales estimates have come down; however, EBITDA has held in

For the past six quarters, >60% of non-structures capitalequipment has been spent on equipment and software, which isultimately a powerful deflationary investment in the economy.

FY07 FY08 FY09 FYE 10 FYE11 11 vs'07-'09 AvgFrom

Jun 10From

Apr 10Revenue/TotEmployee 369 398 365 404 430 14.0% 15.6%

27.5%

14.7%

EBITDA/TotEmployee 63 67 60 74 81 27.2% 25.0%

320

340

360

380

400

420

440

FY07 FY08 FY09 FYE 10 FYE110

1020

30

40

50

60

7080

90

Revenue/Tot Employee (LHS) EBITDA/Tot Employee (RHS)

Can Policy Really Change This Dynamic?

$0

$200

$400

$600

$800

$1,000

$1,200

Mar-9 5 Mar-97 Ma r-99 Ma r-0 1 Mar-03 Mar-05 Ma r-0 7 Ma r-0 9

( $

i n m

i l l i o n s

)

0%

10%

20%

30%

40%

50%

60%

70%

80%

Equipmen t & SoftwareInfo Process ing Equ ip / Software% of Total


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-1,500

-1,000

-500

0

500

1,000

1,500

Jan-

07

May-

07

Sep-

07

Jan-

08

May-

08

Sep-

08

Jan-

09

May-

09

Sep-

09

Jan-

10

May-

10

Sep-

10Full-Time Part-Time for Economic Reas onsPar t-Time for Non-Economic Reasons OtherEmployment

-8,000

-6,000

-4,000

-2,000

0

2,000

4,000

6,000

J a n

- 9 1

J a n - 9

3

J a n - 9

5

J a n

- 9 7

J a n

- 9 9

J a n

- 0 1

J a n - 0

3

J a n

- 0 5

J a n

- 0 7

J a n

- 0 9

-800

-600

-400

-200

0

200

400

600

Private Payrol ls YoY Temporary Help YoY

Or This One?

Source: Bureau of Labor Statistics; Ewing Marion Kauffman foundation; Census Bureau.

Because the cost of hiring permanent workers is so high (health-care, pension, etc.), corporate America hasshifted to hiring people on a temporary or project-oriented basis

Private Payrolls YOY and Temporary Help YOYMonthly Change in Household Employmentand where they end up (Full-Time/Part-Time)

All (more than100%) of hiring has

been part-time


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25

30

35

40

45

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

% L a b o r P a r

t i c i p a t

i o n

Demographics are also Contributing to the Need for Aggressive Policy

US Unemployment Rate by Age

Demographic trends are accentuating these structural problems. Young people are having a hard time finding work, largely because of

an aging population.China is a fascinating dichotomy to this as their population has moved directly into a working age sweet spot. However, the populationages dramatically a few years from now, while the U.S. will exhibits a more normal age demographic over time

This has real implications for near to medium-term growth, inflation, and investment trends in the U.S. and Asia.

US Labor Force Participation of Individuals Aged 55 Years+ 1

China Population Shift2000 2050

US Population Shift2000 2050

0%

5%

10%

15%

20%

25%

30%

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

16 to 19 20 to 24 25 to 34 35 to 44 45 to 54 55+ 1. Shaded areas represent recessions

Source: United Nations, CLSA, Bureau of Labor Statistics


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Residence,13%

Services, 26%

Food, 33%

ManufacturedGoods, 28%

Housing, 42%Transport,16.70%

Apparel,3.70%

Med Care,6.50%

Recreation,6.40%

Food / Beverage,

14.80%

Other, 3.50%

Education / Comm.,6.40%

The second derivative of these demographic trends is a shift in consumption baskets.

Chinas consumption basket is weighted over 2x the US weight in foods.As China develops, this dynamic will shift; however, until this shift China is still at the whim of food inflation. For the Fed toattempt to create inflation in the U.S., it has to try to stimulate it in places such as housing and transport (cars). This is verychallenging today, and is clearly part of why policy is becoming very aggressive.

Chinas CPI Basket Components of CPI Growth YoY - China

US CPI Basket

Policy is Focused on Managing Inflation Expectations, Which is a Difficult Task, butSeemingly Easier than Attempting to Create Jobs

Versus thisSource: Datastream, China Bureau of National Statistics, CLSA


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0

2550

75

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225

D e c - 9

7

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9

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0

Lodging Aw ayMeatsMed CarePhysician SvcRentServicesShelterTransport.TuitionUsed CarMedia RecordingCPICore CPIApparel

DurablesElectricityFoodFood Aw ayChickenFurnitureTechnologyLegal Svc

The Fed has to attempt something which has no historic precedent.

An aging and more skilled work force is seeing inflation in areas such as medical care, legal services and tuition. While technology isenhancing productivity (read technological substitution for human capital) and inflation in areas such as media recordings drop astechnology replaces traditional forms of communication.

Indexed Inflation US since 1997

Pricing Power/Inflation has Some Very Specific Potential, but Not Everywhere

In contrast to this, Apple as aconsumer-driven company hasrevenues up 60% yoy, with desktopsup 58% yoy, away from iPod's andiPadsMedia recording inflation hascome down radically, but thereappears to be real pricing power intheir delivery mechanisms.

Policy to create inflation, and jobs, is a tremendously difficult uphill battle which cannot merely rely on what has been traditional monetary

policy

D i s

p e

r s

i on of

o v e

r 8

x

Wal-Mart, the largest company in thehistory of the world, employs 2.2 million

people or 1% of the US population. 90%of all Americans live within 15 miles of aWal-Mart. Over 7.2 billion purchasingexperiences at a Wal-Mart in a year, vs6.9 billion people in the world Thecompany is a great indicator of true USeconomy.

Tuition

Legal Svc MedCare

MediaRecording

Tech

Same store sales last quarter were down 1.1% vslast year in the economic expansion!

And in the first half of this year, same store saleswere down .8% vs a very tough first half of 2009 .

There is limited pricing power here!

Source: Datastream, Bureau of Labor Statistics, BlackRock Market Intelligence; Any companies listed are not necessarily held in any BlackRock accounts.


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8 , 9 0 0

9 , 0 0 0

9 , 1 0 0

9 , 2 0 0

9 , 3 0 0

9 , 4 0 09 , 5 0 0

9 , 6 0 0

9 , 7 0 0

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U S

$ b i l l i o n ,

S

R e a l Pe rs o n a l C on s . E x p . R e a l Pe rs o n a l In c o m e E xc l . C u rr T ra n s f e r R ec e ip ts

-3

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-1

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2

3

4

5

1 Q09 2 Q0 9 3Q 09 4 Q09 1Q1 0 2Q 10 3 Q1 0 4Q1 0 1 Q11 2 Q1 1 3Q 11 4 Q11

A n n u a

l

Im pa ct fro m Fis ca l P o lic y Im pa ct fro m In ve nto rie s T ota l Im p ac t

0.4

0.8

1.2

1.6

2.0

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9

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A p r -

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A u g - 0

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A p r -

0 9

A u g - 0

9

D e c - 0

9

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1 0

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1 0

And if the Fed Doesnt Ease, the System on its own is Tightening

Income Levels ex Fiscal Stimulus are Flat

Monetary policy is clearly necessary and required today to attempt to combat these demographic and structural forces,

coupled with what is now an embedded policy and business tightening .

Source: US Bureau of Economic Analysis, Goldman Sachs

Benefit to Economy from Fiscal Policies &Low Inventory Levels

Manufacturing ISM New Orders to Inventories Ratio

Especially as orders are now more in line with inventory levels


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8,300

8,3508,4008,4508,5008,5508,6008,6508,700

8,7508,800

Jan Feb Mar Apr May Jun Jul Aug Sep Oct0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

M2 (LHS $Bill ions) YOY Growth (RHS)

0.0036

0.00380.0040

0.0042

0.00440.00460.0048

0.00500.0052

0.0054

0.0056

J a n - 0

9

F e

b - 0

9

M a r -

0 9

A p r -

0 9

M a y - 0

9

J u n - 0

9

J u

l - 0 9

A u g - 0

9

S e p - 0

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t - 0 9

N o v - 0

9

D e c - 0

9

J a n - 1

0

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b - 1

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1 0

M a y - 1

0

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0

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l - 1 0

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1 0

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t - 1 0

M2 is now growing at its fastestpace of the year

Alongside a vigorous QE2 discussion, QE1 may be back at work through three distinct mechanisms.

First, broad money has begun to perk up after a lengthy dormancy as excess bank reserves begrudgingly get put to work with alternative assets (such asTreasuries, Agencies and Mortgages) yielding so little.

Lending standards have eased and loan demand appears to have entered positive territory. Moreover, the M&A pipeline alongside of a thirst for lending frombanks/financial institutions/the markets for 2011 appears to be robust.

Source: Federal Reserve Board, Haver Analytics, Bloomberg

So, Here Comes Policy to Battle all of These Issues Expectations Count

Broad Money RevivalM2 Divided by Monetary Base

Ratio of M2 to the monetary base beginning the process of normalization?

Demand for C&I LoansTightening Lending Standards

-80-60-40-20

020406080

100120

M a r -

0 6

J u n -

0 6

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M a r -

0 7

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D e c - 0

7

M a r -

0 8

J u n -

0 8

S e p - 0

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D e c - 0

8

M a r -

0 9

J u n - 0

9

S e p - 0

9

D e c - 0

9

M a r -

1 0

J u n - 1

0

S e p -

1 0

Banks Tightening C&I Loans to Large Firms

Banks Increasing Spreads of Loan Rates to Large Firms

-70-60-50-40-30-20

-100

102030

M a r -

0 6

J u n - 0

6

S e p - 0

6

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6

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0 7

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0 7

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J u n - 0

9

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9

M a r -

1 0

J u n - 1

0

S e p - 1

0

Banks Reporting Stronger Demand for C&I Loans to Large Firms

Banks Reporting Stronger Demand for C&I Loans to Small Firms


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9,5009,6009,7009,8009,900

10,00010,10010,20010,30010,40010,500

N o v - 0

7

D e c - 0

7

J a n - 0

8

F e b - 0

8

M a r - 0

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8

M a y - 0

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t - 0 8

N o v - 0

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b - 0 9

M a r -

0 9

A p r -

0 9

M a y - 0

9

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t - 0 9

N o v - 0

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b - 1

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1 0

8,000,000

10,000,000

12,000,000

14,000,000

16,000,000

18,000,00020,000,000

O c

t - 0 7

N o v - 0

7

D e c - 0

7

J a n - 0

8

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b - 0

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0 8

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0 8

M a y - 0

8

J u n - 0

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l - 0 8

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8

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t - 0 8

N o v - 0

8

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b - 0

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M a y - 0

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J u n - 0

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l - 0 9

A u g - 0

9

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t - 0 9

N o v - 0

9

D e c - 0

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0

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b - 1

0

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1 0

A p r -

1 0

M a y - 1

0

J u n - 1

0

J u l - 1

0

A u g - 1

0

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1 0

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t - 1 0

Source: Bloomberg

The Wealth Effect is Happening, or At Least Wealth is

The second resurgent QE transmission mechanism is the wealth effect resulting from buoyant asset markets due to low rates and theexpectation of QE2.

Despite a pause during the early summer, the overall post-crisis ~$5.5 trillion in regained US stock market wealth has helped drive USpersonal consumption expenditures to a new all time high.

Unlike other sectors of the post-bubble economy, broad based consumption has regained ALL of its lost ground with the help of a QE-induced wealth effect.

US Equity Market Cap ($millions)

$5.5 Trillion

US Personal Consumption Expenditures Nominal Dollars SAAR

Prior PeakNew All-

Time High


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The Dollar as a Policy Relief Valve is Helping Manufacturing, at Least Temporarily

And QE1s largesse, alongside the anticipated QE2, is creating a third resurgent economic impact - a resumption of US$ weakness. During the second quarter of2010, the US$ strengthened, counter to its secular trend due to the EUR crisis. This led to a dampening effect on the US manufacturing recovery during Q3.However, the lingering effects of QE1 alongside newly aggressive Fed dovishness has helped the dollar resume its down-trade. Right on schedule, regionalmanufacturing surveys are bouncing back this quarter.

Source: Bloomberg

76

81

86

91

Jan Feb Mar Apr May Jun Jul Aug Sep Oct56

58

60

62

64

66

Jan Feb Mar Apr May Jun Jul Aug Sep Oct

05

101520253035

Jan Feb Mar Apr May Jun Jul Aug Sep Oct-10

-5

0

5

10

15

20

25


-30

-20

-10

0

10

20

30

Jan Feb Mar Apr May Jun Jul Aug Sep Oct-5

05

10

152025

3035


DXY Index

Richmond FedDallas Fed

Philadelphia Fed

Empire Manufacturing

Chicago PMI

50525456

586062


ISM Manufacturing


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A persistently dovish Fed clearly creates a stimulative global impact via a weak US$.

On top of the obvious benefits to the export sectors, the direction of the US$ has a very high inverse correlation with globalcapital velocity - when the dollar is weak, velocity is high, and vice versa, as seen here in the rate of accumulation of globalforeign exchange reserve assets.

Indeed, the remnants of QE1 alongside a mere discussion of QE2 has set this phenomenon in motion anew during Q310

Source: Bloomberg

Policy is Also Easing Conditions in the Rest of the World(Whether They Like it or Not)

3,000,000

4,000,000

5,000,000

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7,000,000

8,000,000

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0 5

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t - 1 0

70

75

80

85

90

95

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t - 0 5

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5

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0

DXY Index

Global FX Reserves


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Consequently, Two of the Most Dynamic Global Economies Now Share Inflationand AssetsAs the developing world becomes a larger part of the global economy, and an even larger percentage of global growth,

inflation will become more intertwined with developed countries such as the U.S.This interconnection is very clear as you map Chinas US Treasury ownership to CPI after 2005 the CPI trends becomedirectionally the same for the first time

When you couple this with the demographic trend described earlier, the developing world (and particularly China) isexperiencing dramatic reserve growth and consequently, a need for US assets, like Treasuries

China versus US CPI YoY%

Yet, the Fed is going to buy all of the Treasuries (through LSAP) creating an endless loop of scarcity of assets, and inflows intoemerging markets and inflation creation all over the world

Why are food prices surging globally? The Fed is certainly helping to create this dynamic

This will ultimately bring inflation to the US, yet the risk is that it is coming in the wrong places, such as a global demand for commodities and hard assets, and not where it needs to go for the US economy to experience sticky medium to long-term growth

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J u n .

1 0

CH INA C PI - Y-o -Y (% ) U S CPI - Y-o-Y (%) Ch ina % Own ersh ip of US Ts y

Source: Datastream, China Bureau of National Statistics

And Inflation in Commodities Isnt Helping Homeowners Monetary Policy/QE2


19/35


And Inflation in Commodities Isn t Helping Homeowners. Monetary Policy/QE2Alone Will Only Help in the Short Run. Fiscal Policy Needs to Come Alongside of it or it Wont Work.

Source: Bloomberg

US light vehicle sales remain ~23% below their 20-year average

There is no scarcity of US houses and Americans have enough cars. How does pricing power comeinto the U.S. and what will the next few weeks bring?

Domestic Vehicle Sales

US Privately Owned Housing Starts SAAR US Existing Home Sales SAAR

5

7

9

11

13

15

17

19

J a n - 9

5

J u

l - 9 5

J a n - 9

6

J u

l - 9 6

J a n - 9

7

J u

l - 9 7

J a n - 9

8

J u

l - 9 8

J a n -

9 9

J u

l - 9 9

J a n - 0

0

J u

l - 0 0

J a n - 0

1

J u

l - 0 1

J a n - 0

2

J u

l - 0 2

J a n - 0

3

J u

l - 0 3

J a n - 0

4

J u

l - 0 4

J a n - 0

5

J u

l - 0 5

J a n - 0

6

J u

l - 0 6

J a n - 0

7

J u

l - 0 7

J a n - 0

8

J u

l - 0 8

J a n - 0

9

J u

l - 0 9

J a n - 1

0

J u

l - 1 0

M i l l i o n s o

f U n

i t s

0

500

1,000

1,500

2,000

2,500

J a n - 9

5

J a n - 9

6

J a n - 9

7

J a n - 9

8

J a n - 9

9

J a n - 0

0

J a n - 0

1

J a n - 0

2

J a n - 0

3

J a n - 0

4

J a n - 0

5

J a n - 0

6

J a n - 0

7

J a n - 0

8

J a n - 0

9

J a n - 1

0

T h o u s a n

d s o

f H

o m e s

3.03.54.04.55.05.56.06.57.07.5

J a n - 9

5

J a n - 9

6

J a n - 9

7

J a n - 9

8

J a n - 9

9

J a n - 0

0

J a n - 0

1

J a n - 0

2

J a n - 0

3

J a n - 0

4

J a n - 0

5

J a n - 0

6

J a n - 0

7

J a n - 0

8

J a n - 0

9

J a n - 1

0

M i l l i o n s o

f H o m e s


20/35


1993

1994

1995

1996

19971998

1999

2000

2001

2002

2003

2004 2005

2006

2007

2008

2009

2010

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

-6.00 -4.00 -2.00 0.00 2.00 4.00 6.00 8.00RETAIL SALES YOY %

C P I Y O Y %

QE2 is Half of the Battle And We are About to Watch that Play Out

Monetary policy alone should put 2011 in the upper left corner

We have used this chart several times to show the Fed has to put 2011 squarely into the upper right quadrant. Yet, it is facing major headwinds to doing that and we think that it cant be accomplished unilaterally through monetarypolicy alone

Source: Bloomberg. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index.

CPI vs. Retail Sales Since 1993

g g teAverage 22.00 10/31/2010 6.79 12/31/2009 23.45 12/31/2008 (38.49) 12/31/2007 3.53 12/29/2006 13.62

12/30/2005 3.00 12/31/2004 8.99 12/31/2003 26.38 12/31/2002 (23.37) 12/31/2001 (13.04) 12/29/2000 (10.14) 12/31/1999 19.53 12/31/1998 26.67

12/31/1997 31.01 12/31/1996 20.26 12/29/1995 34.11 12/30/1994 (1.54) 12/31/1993 7.06 Average 7.66

SPX Index - Total % Return

QE1 d h A i i i f QE2 H S d H l S P f h E


21/35


JanuaryFebruary

March

April

May

June

July

AugustSeptember

October

-0.3%

-0.2%

-0.1%

0.0%

0.1%

0.2%

0.3%

0.4%

-4.0% -2.0% 0.0% 2.0% 4.0% 6.0% 8.0% 10.0%

Retail Sales

C P I M O M

QE1 and the Anticipation of QE2 Have Started to Help Some Parts of the Economy,Even if Short Term.

It is hard to argue that QE2 anticipation has created some benefit to retail sales or homes at this point. The data is

inconclusive. However, this shift to the upper right quadrant for both is critical and wont happen with only monetarypolicy.

The latent effects of QE1 and the anticipation of QE2 have appeared to shift retail sales vertically, at least somewhat, after dipping in the late spring and summer.

Home sales though seem very far from theupper right quadrant, like they were earlier inthe decade.

Retail Sales vs. CPI for 2010

Source: Bloomberg. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index.

Change in Home Sales vs. Change in Home Prices

2010

2009

2008

2007

2006

2005 2004

20032002

2001

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

-30% -20% -10% 0% 10% 20%

YOY Change in Hom e Sales

Y O Y C h a n g e

i n H o m e

P r i c e s


22/35


$-$50

$100$150$200$250

$300$350$400

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010*

The inflation imported back from the rest of the world through this Fed induced liquidity-transmission process is driving

up crude goods, which will compress operating margins for US companies The lack of pricing power for manyindustries in the US will result in commodity price increases reducing margins, as companies have no ability to pass alongincreased input costs.

And it May Hurt in Some Other Parts of the Economy

Source: Credit Suisse

US Imports from China ($ in bn)

Since Chinas accession to the WTO, USimports from China are up more than

40%...And 4 of the top 6 imported goodsare significantly influenced by crudecommodity pricesmeaning USintermediate producers are increasinglyexposed to commodity price increases

In addition, rising crude costs at the end of the quarter hurtour results

U.S. Oil Refiner, $7.0bn EV the decrease in gross margin was primarily due tohigher year-over-year raw material pricesthe normal lagbetween raw material cost inflation and higher effective

pricing has pressured our gross marginpersistently highraw material costs did not abate in the third quarter andsome commodities such as titanium dioxide are still rising.

U.S. Chemical company, $9.0bn EV the industry is experiencing the rising cost of rawmaterials, cotton, labor cost increases throughout the FarEast, capacity issues at factories and in logisticstherising costs challenged our margins.

U.S. Apparel company, $2.0bn EV

Quotes from Last Weeks Earnings Calls Intermediate Companies Margin Compression w/ No Pricing Power and Higher Costs

Half of Higher COGS Passed

No Higher COGS Passed

Profit Lost for $1B Rev CoCOGS up 10%COGS up 20%COGS up 10%

COGSup 20%

%COGS SourcedFrom China Current Gross

MarginNew Gross Margin

5.0% 25.0% 24.8% 24.5% 24.6% 24.3% $(7.5)

10.0% 30.0% 29.5% 29.1% 29.3% 28.6% $(14.0)15.0% 35.0% 34.3% 33.7% 34.0% 33.1% $(19.5)20.0% 40.0% 39.2% 38.3% 38.8% 37.6% $(24.0)25.0% 45.0% 44.0% 43.0% 43.6% 42.3% $(27.5)30.0% 50.0% 48.9% 47.8% 48.5% 47.0% $(30.0)35.0% 55.0% 53.8% 52.6% 53.4% 51.9% $(31.5)40.0% 60.0% 58.7% 57.5% 58.4% 56.8% $(32.0)45.0% 65.0% 63.7% 62.4% 63.4% 61.9% $(31.5)

50.0% 70.0% 68.7% 67.5% 68.5% 67.0% $(30.0)

Top US Imports from China 2009 ($ in bn) $ AmtElectrica l machinery and equipment 72 .9$Power generation equipment 62.4$Apparel 24.3$Toys and games 23.2$Furniture 16.0$Iron and steel 8.0$


23/35


0%

2%

4%

6%

8%

10%

12%

14%

J a n - 7

3

J a n - 7

5

J a n - 7

7

J a n - 7

9

J a n - 8

1

J a n - 8

3

J a n - 8

5

J a n - 8

7

J a n - 8

9

J a n - 9

1

J a n - 9

3

J a n - 9

5

J a n - 9

7

J a n - 9

9

J a n - 0

1

J a n - 0

3

J a n - 0

5

J a n - 0

7

J a n - 0

9

0%

2%

4%

6%

8%

10%

12%

1Q85 1Q87 1Q89 1Q91 1Q93 1Q95 1Q97 1Q99 1Q01 1Q03 1Q05 1Q07 1Q09

Source: Capital IQ, Goldman Sachs, Compustat, Bloomberg

Average

How should a corporate CEO/CFO think about all of this today?

The value of their cash-holdings will go down, while their margins potentially compress What then is the best use of that cash then? M&A and stock repurchases

M&A cuts costs and creates synergies; i.e. fewer jobs. If rates are kept low, financing is inexpensive and incentsborrowing to finance this M&A, even if it is levered M&A(LBOs). Low borrowing rates allow for the repurchase of stock,which makes more sense if business prospects are nominalgoing forward.

NET RESULT: More M&A, more LBOs, more stock buybacks.ECONOMIC IMPLICATIONS: More leverage on the system;companies de-capitalize, reducing future economic growthprospects.JOBS ARE CUT, NOT GAINED - DEFLATION in HOMES, CARS and DURABLES OCCURS

Historical Equity FCF Yield (S&P500)

US banks have 10% of their assets in cashthe highest since 1982

Recessions

Sep 81: 13%

Apr 10: 10.1%

Aug 08: 8.3%

Cash as % of Assets (S&P500 ex-Financials)

So What Do Companies Do Without a Fiscal Incentive to Spend for Growth or Hire?

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

9.00%

J a n - 9

0

J a n - 9

2

J a n - 9

4

J a n - 9

6

J a n - 9

8

J a n - 0

0

J a n - 0

2

J a n - 0

4

J a n - 0

6

J a n - 0

8

J a n - 1

0

l l l h l


24/35


Few countries have a corporate income tax that is higher than the U.S. When you aggregate federal and state incometaxes, it becomes obvious that the US politicians must be careful not to drive businesses out of the U.S., based on overlyaggressive tax measures.

Current Global Corporate Tax RatesUS Marginal Corporate Tax Rate since 1909

FISCAL POLICY COMPLETELY CHANGES THIS DYNAMIC HOWEVER

Taxes continue to be an area where the government still has room to make changesTax incentives to hire, to build, to grow businessReduced taxes on cash held overseas for productive domestic use, shortened depreciation schedules for new projects, etc

WE BELIEVE THAT FISCAL POLICY IS THE ONLY WAY TO CREATE JOBS, TO ENSURE A LASTING RECOVERY, ALONGSIDE OF THEEASY MONETARY POLICY.

Source: Capital IQ, FactSet, Citi, IRS, www.worldwide-tax.com

But Fiscal Policy Can Help Channel Resources to Create Longer-Term,Sustainable Economic Growth

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

A r g e n t

i n a

A u s t r i a

B e

l g i u m

B u

l g a r i a

C h i n a

C y p r u s

D e n m a r k

E s t o n

i a

F r a n c e

G i b r a l

t a r

H o n g

K o n g

I n d i a

I r e l a n

d

I t a

l y

L a t v

i a

L u x e m

b u

r g

M e x

i c o

M o r o c c o

N e

t h e r l a n

d s

N o r w a y

P a n a m a

P o l a n

d

R o m a n

i a

S a u

d i

S i n g a p o

r e

S l o v e n

i a

S p a

i n

T a

i w a n

T u n i s

i a

U . K .

U . S . A .

Z a m

b i a

0%

10%

20%

30%

40%

50%

60%

1 9 0 9

1 9 1 6

1 9 1 8

1 9 2 2

1 9 2 6

1 9 2 9

1 9 3 2

1 9 3 8

1 9 4 1

1 9 4 6

1 9 5 1

1 9 6 4

1 9 6 8

1 9 7 1

1 9 7 9

1 9 8 3

1 9 8 7

1 9 9 3


25/35


The Math is Very Compelling

Impact on Effective Tax Rate and Multiples(Assumes current fwd multiple of 12.5x)

Change in Net Margin due to Depreciation Changes

Lending programs to small businesses to encourage growth, coupled with shortened depreciation schedules for

companies to build infrastructure are incredibly powerful incentives to create sustainable growth AND CAN BE MUCHMORE LONG LASTING THAN UNILATERAL MONETARY POLICY

Outright changes in depreciation rules have a materialimpact on net margins or a companys overall profitability.

Regardless of how the government drives changes ineffective tax rates, it is clear that these possible changesmust be considered because they can have a materialimpact to forward multiples

BlackRock cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. BlackRock isnot engaged in rendering any legal, tax or accounting advice. Please consult with a qualified professional for this type of advice.

Marginal Tax Rate25.0% 30.0% 35% 40.0% 45.0%

-50.0% 0.5% 0.7% 0.8% 0.9% 1.0%-40.0% 0.5% 0.6% 0.7% 0.8% 0.8%-30.0% 0.4% 0.5% 0.5% 0.6% 0.7%-20.0% 0.3% 0.3% 0.4% 0.4% 0.5%-10.0% 0.1% 0.2% 0.2% 0.2% 0.3%0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

10.0% -0.2% -0.2% -0.3% -0.3% -0.3%20.0% -0.4% -0.5% -0.6% -0.7% -0.7%

30.0% -0.7% -0.8% -1.0% -1.1% -1.3%40.0% -1.1% -1.3% -1.5% -1.8% -2.0%50.0% -1.6% -2.0% -2.3% -2.6% -3.0% %

C h a

n g e

i n D e p r e c

i a b l e

L i f e

2.7x12%

1.9x9%

1.2x6%

0.6x3%

0.0x0%

-0.5x-3%

-1.0x-6%

-1.5x-9%

I n c r

i n E f f e c

t i v e

T a x

R a

t e

C h

an

g ei nF w

d P

/ E


26/35


How Should We Invest Knowing This?

Source: Bloomberg, Barclays. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index.

Large scale asset purchases are here now, and we believe yields should continue to be pressed down, despite

inflation expectations rising

Yields continue to fall

The cocktail of lingering QE1, andthe vigorous QE2 discussionincluding the possibility of newunconventional tools has had a veryobvious impact. Since Bernankes

groundbreaking Jackson Holespeech, US market-based inflationexpectation indicators have perkedup smartly. 5-year treasury yield minus 5-year TIPS yield

Implied forward inflation has popped 50 basis points since Jackson Hole

Jackson

Hole

Yields are stillstaying low

Yield To Worst U.S. Corporate IG U.S. Corporate HY U.S. MBS ABS CMBS US Treasury Index12/31/2008 7.50% 19.43% 3.63% 10.45% 11.57% 1.55%03/31/2009 7.71% 18.12% 3.71% 7.92% 12.13% 1.79%06/01/2009 6.42% 13.51% 4.47% 7.07% 10.28% 2.40%09/30/2009 4.85% 10.31% 3.89% 3.04% 7.48% 2.16%12/31/2009 4.73% 9.06% 4.15% 2.88% 7.12% 2.46%01/29/2010 4.46% 8.96% 3.86% 2.43% 6.24% 2.18%

02/26/2010 4.47% 9.15% 3.89% 2.36% 5.95% 2.15%03/31/2010 4.48% 8.47% 4.01% 2.40% 5.55% 2.37%04/30/2010 4.27% 8.11% 3.96% 2.39% 5.19% 2.26%05/31/2010 4.46% 9.28% 3.64% 2.45% 5.65% 2.03%06/30/2010 4.23% 9.16% 3.10% 2.20% 5.31% 1.77%07/30/2010 3.93% 8.34% 2.73% 1.92% 4.90% 1.65%08/31/2010 3.74% 8.46% 2.48% 1.75% 4.57% 1.44%09/30/2010 3.63% 7.80% 3.26% 1.68% 4.19% 1.41%10/28/2010 3.61% 7.29% 3.11% 1.64% 4.08% 1.42%


27/35

E h P l i h C i N Gi All f h C C


28/35


Retail fund flows continue

With potentially levering M&A around the corner, and capital flows into high yield as strong as they have been, being much more selective in creditnow is importantBut credit is still a tremendous portion of the yield availability in fixed income today.

Since everyone now expects that inflation is coming (somewhere down the road), and that it is somewhat priced in today, taking some M&A-resilient companies credit in the longer end of the curve, is starting to look attractive again

Enter the Pool with Caution Now, Given All of these Cross-Currents

Source: Credit Suisse

IG/HY Maturity Sum of Amt Outstanding Avg Yield Avg OAS Avg RiskFree Yield0-3yrs 85,111,924 7.32 6.67 0.653-5yrs 231,034,180 7.40 6.52 0.885-7yrs 263,260,657 7.96 6.51 1.457-10yrs 217,621,490 7.33 5.23 2.1010-20yrs 47,833,533 7.95 4.98 2.97

20-30yrs 35,185,352 10.08 5.90 4.1830+ 2,622,987 7.95 4.22 3.73

HY Total 882,670,123 7.68 6.10 1.580-3yrs 688,863,619 1.32 0.95 0.383-5yrs 642,135,090 2.11 1.26 0.855-7yrs 380,918,457 3.39 1.86 1.527-10yrs 698,336,605 3.93 1.71 2.2310-20yrs 175,477,029 5.07 1.90 3.1720-30yrs 607,595,984 5.66 1.94 3.7230+ 44,652,796 6.00 2.15 3.85

IG Total 3,237,979,580 3.37 1.54 1.83Grand Total 4,120,649,703 4.29 2.51 1.78

IG

HYSome value

here nowwith theTreasurycurve socheap?

Yield to Worst by Maturity Bucket in the Credit Index

4.033.842.9748.5031.428.800.12CMBS1.653.510.270.700.640.200.00ABS3.112.9732.735.209.9620.001.02MBS Passthrough3.173.0435.9754.3042.0129.101.14Securitized3.705.606.6414.2013.5413.900.25Financial Institutions3.897.972.117.109.153.400.08Utility3.467.149.9118.3023.1614.100.34Industrial3.596.6918.6639.6045.8531.500.67Corporate1.153.741.190.200.500.300.01Supranational3.287.081.150.700.971.400.04Sovereign4.358.961.143.404.811.900.05Local Authority1.243.318.571.704.922.200.11Agency1.724.2512.056.1011.215.800.21Government-Related1.395.4533.33(0.00)0.93(0.20)0.46Treasury2.484.67100.00100.00100.0066.202.48Total

Yield toWorstOAD

Market Value[%]

OAS[%]

Yield to Worst[%]

OAS[cntr]

Yield to Worst[cntr]

US Aggregate(Statistics, Unhedged)

Source: Barclays Live, POINT

0.5%1.5%2.5%3.5%4.5%5.5%

6.5%

0-3yrs 3-5yrs 5-7yrs 7-10yrs 10-20yrs 20-30yrs 30+yrs

Ma turity Bucke t

% Y i e

l d

All in Yield OAS

Companies Will Grow Dividends or Just Buy Back Stock (If No FiscalEncouragement is Given) Either Way Equities are Hard Not to Like for


29/35


With real yields staying low for a while, it is hard not to like stable dividend yields in equities. Despite having used the chart

on the bottom right for three straight months, we still think that it is very compelling today, especially if you think that fiscalpolicy may not come fast enough and stock buybacks and M&A happen sooner

While share price appreciation may accountfor the majority of shareholder returns inany given year, on a 5-year time horizonsince 1871, dividends have accounted for ~80% of total return.

This trend has held true across much of theindustrialized world over the past 40 years.

This consistency of return, combined withthe depressed P/Es and record amounts of cash-on-hand, make dividend-yieldingstocks very attractive now. Maybe as asurrogate for low-yielding high quality fixedincome?

Source: CapitalIQ, Barclays Capital, GSO

Real Ten Year Yield 1

1Real Ten Year Yield represents the GDP Deflator Minus Ten Year Yield

S&P 500 Contribution to Total Return S&P 500 Dividend Yield vs. 10-Yr Treasury

Encouragement is Given). Either Way, Equities are Hard Not to Like for Yield.

-10%

-5%

0%5%

10%

15%

20%

1871-2009 1982-2000 2000-2009

Dividend Yield Growth in Real Dividends Change in Valuation

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

D e c - 9

9

J u n - 0

0

D e c - 0

0

J u n - 0

1

D e c - 0

1

J u n - 0

2

D e c - 0

2

J u n - 0

3

D e c - 0

3

J u n - 0

4

D e c - 0

4

J u n - 0

5

D e c - 0

5

J u n - 0

6

D e c - 0

6

J u n - 0

7

D e c - 0

7

J u n - 0

8

D e c - 0

8

J u n - 0

9

D e c - 0

9

J u n - 1

0

-10%

-5%

0%

5%

10%

1 9 4 6

1 9 5 0

1 9 5 4

1 9 5 8

1 9 6 2

1 9 6 6

1 9 7 0

1 9 7 4

1 9 7 8

1 9 8 2

1 9 8 6

1 9 9 0

1 9 9 4

1 9 9 8

2 0 0 2

2 0 0 6

2 0 1 0

0%2%4%6%8%10%12%14%16%18%

S&P 500 Div. yld - 10yr T yld % S&P 500 Dividends yld % (rhs)

10yr Treas ury yld (rhs)

Emerging Market Investments are an Old Story by Now but Old Stories Can Still Be


30/35


-150%

-100%

-50%

0%

50%

100%

150%

Q 4 1 9 9 9

Q 2 2 0 0 0

Q 4 2 0 0 0

Q 2 2 0 0 1

Q 4 2 0 0 1

Q 2 2 0 0 2

Q 4 2 0 0 2

Q 2 2 0 0 3

Q 4 2 0 0 3

Q 2 2 0 0 4

Q 4 2 0 0 4

Q 2 2 0 0 5

Q 4 2 0 0 5

Q 2 2 0 0 6

Q 4 2 0 0 6

Q 2 2 0 0 7

Q 4 2 0 0 7

Q 2 2 0 0 8

Q 4 2 0 0 8

Q 2 2 0 0 9

China US Log. (China) Log. (US)

-$0.50-$0.40-$0.30-$0.20-$0.10$0.00$0.10$0.20$0.30$0.40$0.50$0.60$0.70$0.80$0.90$1.00$1.10

1 9 5 3

Q 1

1 9 5 6

Q 1

1 9 5 9

Q 1

1 9 6 2

Q 1

1 9 6 5

Q 1

1 9 6 8

Q 1

1 9 7 1

Q 1

1 9 7 4

Q 1

1 9 7 7

Q 1

1 9 8 0

Q 1

1 9 8 3

Q 1

1 9 8 6

Q 1

1 9 8 9

Q 1

1 9 9 2

Q 1

1 9 9 5

Q 1

1 9 9 8

Q 1

2 0 0 1

Q 1

2 0 0 4

Q 1

2 0 0 7

Q 1

2 0 1 0

Q 1

Emerging Market Investments are an Old Story by Now, but Old Stories Can Still BeGood Stories.And we still like EM as an asset class due to some very tangible structure reasonsAs we started discussing in our February call, and mentionedearlier, we are concerned about the ability to use leverage to drive US GDP growth.As we define it, the Diminishing Marginal Utility of Debt should decrease as an economy achieves appropriate leverage levels.Thus, the developing world clearly has an advantage in using leverage here (Chinas marginal utility of debt has rebounded) and could present someattractive investment opportunities

Diminishing Marginal Returns in the US (through Q2 2010)

We believe China canstill effectively useleverage to drive GDP

growth to a similardegree as the US inthe industrial boom ofthe 1950s, yet itclearly will bemanaged within apragmatic set ofmedium to long-termgoals

R e b o u n

d i n g

Diminishing Marginal Returns in the China versus US

Source: Federal Reserve, PBOC, China National Bureau of Statistics

Another Oldie but Possibly Still Goodie


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Another Oldie, but Possibly Still Goodie

Source: Bloomberg, Barclays; As of 31 October 2010; Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index.

Duration has been the star performer of the year, but it hasnt been over the past few months Depending on the level, wedont think that this opportunity is over, yet we are being tactical here as levels are clearly less attractive, and the range of opportunity is obviously quite narrow today

Total Return YTD 3 Month Return 1 Year Return 3 Year Return 10 Year Return

US Treasury 8.57 2.38 7.82 22.25 80.38

US Intermediate Treasury 7.55 2.24 7.14 21.06 71.5

US Long Treasury 15.15 3.14 12.18 28.33 109.13

US Aggregate 8.33 2.09 8.49 22.76 85.43

US Agency 5.79 1.56 5.81 20 79.12

US Local Authorities 10.6 2.43 9.01 21.79 104.13

US Government Sovereign 8.12 2.3 7.61 21.88 81.63

US Credit 10.67 3.34 11.9 25.11 98.39

US Credit Corp 10.9 3.38 12.4 25.42 97.92

US Credit Industrial 10.96 3.26 12.32 29.64 106.86

US Credit Utility 11.43 3.05 12.33 31.68 89.25

US Credit Finance 10.65 3.66 12.56 20 92.09

US Securitized 7.26 1.2 7.48 22.88 83.13

US MBS 6.14 0.81 6.23 23.82 84.08

US CMBS Aggregate 20.59 5.61 22.33 24.9 99.02

US Intermediate Corp 10.25 3.37 11.8 25.18 92.52US Credit Corp 10+ Yrs 12.9 3.46 14.27 26.84 117.54

S&P 500 7.84 8.33 16.91 (5.55) (0.15)

Russell 2000 13.59 7.96 26.08 (2.73) 0.18

Oil (CL1) 4.95 5.50 8.17 (10.91) 149.00

Gold (GOLDS) 23.21 14.44 29.29 71.67 412.98

Especially with the Supply Engine in Neutral


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Especially with the Supply Engine in Neutral

Source: JPMorgan, EPFR, Credit Suisse

And while we continue to use the chart on

the right to show declining supply, webolster this with another supply projectionwhich shows the impact on supplyinclusive of projected Fed policy

Buying front-end yield where available inplaces like asset-backs, while tacticallymanaging mortgage risk is going to be keyfor the next number of months

Fixed Income Net Supply

2004 2005 2006 2007 2008 2009 F2010 F2011 F2012

IG Corps 215 169 326 408 103 55 100 200 185

HY Corps 44 13 42 52 -10 103 100 100 90

EM Corps 46 72 86 101 42 111 80 90 100

BABs 0 0 0 0 0 59 110 122 134

Non-Agency MBS 452 615 504 131 -345 -370 -265 -205 -175

Agency MBS 57 149 300 528 512 459 -15 80 150

CMBS 78 105 175 165 -31 -35 -30 -30 -30

ABS 6 55 42 51

CLOs 23 47 90 79

Agency Debt 88 -79 35 267

-47 -23 -90 -50 -25

19 -14 -5 -15 -40

233 -473 0 -160 -145

Long-Term TSY 296 263 177 135 396 1,549 1,557 1,132 800

Total 1,305 1,409 1,777 1,917 872 1,421 1,542 1,264 1,044

TSY % of Net Issuance 23% 19% 10% 7% 45% 109% 101% 90% 77%

US Taxable Fixed Income Net Issuance, Net Issuance excluding change in Fed and Treasury Holdings, and Gross Issuance 2010 and2011 Forecasts

-3.73%-7.50%-18.51%2759%-28.75%0.37%Full Year % Chg4,7794,9645,3671,3221,623571,2421,7441,738Total

901004890100459010048Build America Bonds125110151(305)(306)(524)(315)(325)(477)Asset Backed180200189606095606092HY Corporates32531034025(24)26625(24)266IG Financial Corps375340376228247286228247290IG Non-Fin Corps

1,3001,1501,500559(86)(720)188-415Agency Mortgages1651722182075802075132SSAs (non-US)

219275348(211)30(620)(254)17(475)US Agencies2,0002,3072,1978561,5271,1461,2001,5941,447Treasuries

2011 GrossIssuanceForecast

2010 GrossIssuanceForecast

2009 GrossIssuance

2011 Net Issuanceex Fed/Tsy Chgs



2011 NetIssuanceForecast

2010 NetIssuanceForecast

2009Net Issuance

Is it Possible that Policy is Effective, That Correlations Drop, and That RelativeValue Investing Begins to Work Again?


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50

55

60

65

70

75

80

85

N o v - 0

8

D e c - 0

8

J a n - 0

9

F e

b - 0

9

M a r -

0 9

A p r -

0 9

M a y - 0

9

J u n - 0

9

J u

l - 0 9

A u g - 0

9

S e p - 0

9

O c

t - 0 9

N o v - 0

9

D e c - 0

9

J a n - 1

0

F e

b - 1

0

M a r -

1 0

A p r -

1 0

M a y - 1

0

J u n - 1

0

J u

l - 1 0

A u g - 1

0

S e p - 1

0

O c

t - 1 0

Source: Bloomberg

Realized Correlation CBOE and SPX

We love the fact that correlations are breaking down somewhat, leaving many more spread and basisopportunities for active management of individual securities

Value Investing Begins to Work Again?This Will Be Very Important to Determine Return Opportunities in 2011

Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index.


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1011 blackrock fi slides - qe2 overview

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