“Bringing you national and global economic trends for over 25 years” Economic and Market

Despite a continuous advance in the stock market, a steady stream of better-than-expected economic reports around the globe, back-to-back quarters of outperforming earnings reports, and rising earnings estimate revisions for the third quarter, doubts surrounding the strength and durability of any economic or stock market recovery remain widespread. A recent national AP poll suggests 80 percent of Americans currently believe the economy remains poor and 60 percent believe the economic policies put in place by the U.S. government will not work! However, positive fundamental forces have improved economic conditions around the globe and, despite ongoing pessimism, these forces should continue to promote further recovery in the coming year.

Six Forces For Economic Growth!!!?Several factors are combining to produce an economic recovery. First is massive and unprecedented economic policy stimulus! Since the Lehman collapse one year ago, the annual growth in the M2 money supply has surged to between 8 and 10 percent. Trailing 12-month Federal deficit spending has exploded from about $350 billion to almost $1.4 trillion! Short-term interest rates were lowered to essentially zero, and long-term bond yields hover at some of the lowest levels in U.S. history! Moreover, the yield curve remains at one of its steepest positions in the postwar era! Finally, oil prices are down by more than one-half from their peaks last summer!

Second is the reversal of the U.S. corporate purge! In the last year, businesses have been preparing to survive a second coming of the Great Depression by purging inventories, payrolls, and capital spending plans. Now, as it becomes clear a depression will not result, and indeed an economic recovery is forming, most businesses find themselves understaffed without any goods on the shelf! Overall, economic growth should be enhanced as business is forced to “reverse the purge”!

Third is a slow steady rise in economic confidence. The Conference Board’s Consumer Confidence Index has risen from its all-time low of 25.3 in February to 54.1 in August. However, despite this significant recovery, the confidence index is only back to a level that approximates the recessionary lows of the 1975, 1980, 1982, 1990, and 2001 recessions! Therefore, rising confidence should remain a central force in driving economic growth for the foreseeable future!

Fourth, after constantly subtracting from economic growth, housing and autos will likely “add” to third-quarter real GDP growth for the first time since early 2006! Simply by no longer representing a “negative” force, even if housing and autos only flatten in the next year, they will be additive to overall economic growth.

Fifth, domestic net exports are now boosting U.S. real GDP growth! Indeed, international trade may well prove a dominant force for U.S. growth in the next several years! Global export trends have recently started to rise again after suffering a major recessionary collapse last year. The U.S. trade deficit with the emerging world has finally been improving for the first time in at least a decade.

Finally, two major negative forces for the recovery—rising mortgage rates and surging energy prices—have stalled in the last few months, even though economic reports have continued to improve. The longer these two negatives remain range-bound, the more time this recovery has to mature, gain strength, and achieve solid footing.

Massive policy stimulus, a corporate purge reversal, improving economy-wide confidence, a bottoming in housing and autos, an improving contribution from net exports, and a stall in the rise of mortgage rates and oil prices should foster a recovery that continues to surpass expectations. Our best guess is for real GDP growth to average around 4 percent in the next 18 months, without a high probability on double-dip concerns.

In This Issue:

Monetary Worry!!?

Six Forces For Growth!?!

Consumer May Not Be DOA??!

It’s A Low, Low, Low Rate World!!?

May “Buy-And-Hold” RIP!!??

Gold Prices Overvalued??!

Will Velocity Turn??!?

An Earnings-Driven, À La 1960s-Style Bull Market!!!?

September 2009

2009-Issue 5

Economic & Market Perspective

Too Early To Evaluate The U.S. Consumer!??!Many expect a sluggish recovery because they believe the U.S. consumer will be forced to deleverage. Some already point to current sluggishness in consumer spending and debt growth as evidence that household behaviors have changed. We think it is too early to evaluate whether the U.S. consumer will respond to policy stimulus and boost spending or whether spending is likely to stay subdued despite stimulus as households embark on balance sheet restoration.

Why shouldn’t current consumer confidence be low and spending trends weak when job losses are still pronounced and private income trends are still contracting? We do not expect healthy consumer spending “until” job creation returns. Probably a couple of quarters of positive real GDP growth and at least a few months of job gains are required before judgment can be passed on the postrecession state of the U.S. consumer.

In the meantime, we are encouraged by a few indicators. During this recession, consumer spending has actually remained stronger than expected considering the collapse in job creation. Typically, real consumption growth has been about 2 to 3 percent faster than job growth. In the last year, however, even though jobs have declined by about 4.5 percent, real consumer spending is down less than 1 percent! We also are encouraged by the response of household spending to “deals”! The Cash for Clunkers program and housing sales promoted by rapidly falling foreclosure pricing insinuate that widespread rumors of the consumer’s death may again be greatly exaggerated! We suspect, after a couple of quarters of renewed real GDP growth, most will be surprised by a revival in the old “spendy culture” of the U.S. consumer.

Best News For Jobs? ....... Profits!!!The pace of job creation will ultimately determine consumer spending growth. And, the most important force behind job creation is profits, where the news has been encouraging! Total U.S. corporate profits have risen in each of the first two quarters this year by almost a 23 percent annualized pace! More important, profit per job has risen at almost a 30 percent annual rate! Since at least 1960, whenever profit per job has risen by this much from recession lows, nonfarm payroll employment was either at or near a bottom.

Emerging World Consumer IS A Force For GROWTH!!!?Even if U.S. consumption does prove subdued in the coming recovery, it may be at least partially offset by a nontraditional outsized contribution from newfound emerging world consumers. By our estimates, total private emerging world consumption in U.S. dollars has risen from about 60 percent of U.S. consumption in 2003 to almost 92 percent of U.S. consumption in 2008! Moreover, in recent years, emerging world consumption has grown more than twice as fast as U.S. consumption and has outpaced U.S. spending in each of the last 6 years! Finally, compared to U.S. households, this new consumer force is much younger and possesses burgeoning first-time desires, low debt, and high savings!

For those who believe the emerging world is not yet developed enough to represent a meaningful global consumer force, look no further than the “emerging world headliners”! Imports from emerging world “headliners” (i.e., from China, India, and Mexico) as a percent of total world imports has risen from only about 5 percent one decade ago to about 11 percent today. For comparison, U.S. imports comprised more than 15 percent of world imports in 1998 (or about three times the imports from the emerging world headliners) but comprise only 12.4 percent today (only about 1 percent more than the “headliners”)! This may be the first global recovery where emerging world imports constitute a very meaningful proportion of global trade.

Inflation, Deflation, Or ……. Neither????Inflation typically declines for 18 to 24 months “after” a recession ends. Unemployment (both labor and factory capacity) created during the recession produces downward pressure on both core consumer prices and wages even though real GDP growth again turns positive.

Currently, there are both inflation and deflation alarmists. Some believe the massive policy response to this crisis will eventually prove inflationary; however, others believe this crisis has not yet ended and expect a “stage two,” which will produce destructive deflation. Our own view is the economy is most likely headed for a period of “price stability,” which may calm fears on both ends of the spectrum. Inflationists may gain fuel as real GDP growth turns positive but will probably be kept in check by monthly core consumer price inflation and wage reports that remain moderate. Even though core consumer price and wage inflation will likely decelerate throughout 2010, deflationists may have a hard time gaining traction if real GDP growth averages (as we expect) around 4 percent. A traditional post recession deceleration in inflation could force the 2010 annual core consumer price inflation rate to between 0 and 1 percent and the annual wage inflation rate to between 1 and 2 percent. If real GDP growth is as strong as we think is likely, when combined with a decelerating core inflation picture, it may leave a bullish impression of “growth with price stability”!

Longer-term, inflation risk has certainly been elevated by the massive accommodative policies introduced during this crisis. However, ultimate inflation risk will depend on many factors (e.g., how fast policies are reversed, bond vigilante reactions, speed of recovery, strength of U.S. consumer spending, growth rate of emerging world, U.S. dollar weakness, recovery in borrowing propensities, etc). We are not convinced the U.S. is or is not headed for a longer-term inflationary episode and will monitor how these factors evolve. In the meantime, solid real growth with stable core prices seems most likely during the next couple years.

Gold & TIPS???!Because we expect core inflation to remain relatively tame in the next couple years, we would caution investors against becoming too overexposed to inflation-protected investments. Diversification demands some exposure to inflation hedges, but we recommend underweighting at least two major inflationary

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September 2009

plays—gold and TIPS. Currently, these investments are simply too popular, reflecting widespread concerns about inflationary possibilities.

Ten-year Treasury TIPS are currently priced at a 1.8 percent consumer price inflation rate, while the actual current core inflation rate is only 1.5 percent and decelerating. TIPS are not necessarily overvalued, but they are not extremely cheap and may prove disappointing if core inflation does decline as we think is likely.

Gold prices do appear “overvalued”! Between 1980 and 2008, the price of gold as a ratio of the overall CRB commodity price index traded between 1.25 and 2.5 times. Recently, gold traded at more than four times the CRB index! The price of gold surged on safe-haven demands during the worst of the crisis. While most markets have since reversed crisis safe-haven premiums or discounts (e.g., Treasury bonds, U.S. dollar, junk bonds, cyclical stocks, etc.), the price of gold has never relinquished its crisis premium. Why? It is possible the crisis safe-haven premium has been replaced by a postcrisis inflation premium. However, we believe investments based on either a deflationary meltdown or an inflationary blowoff will prove disappointing.

May “Buy-And-Hold” R.I.P.!!!?The 2008 crisis killed the “buy-and-hold” mantra of investing! It left investors with zero returns for more than a decade and has consequently raised the popularity of “market-timing.” This popularity switch between buy-and-hold and market-timing is an old one. By the end of WWII after about 15 years of malaise in the U.S. stock market, very few investors even wanted to touch stocks! However, for the next 20 years, the stock market embarked on the best buy-and-hold investment era in its history. As a result, by the end of the 1960s, nearly everyone bought “good company stocks” and simply held them. After all, such an approach had worked well for almost two decades. Indeed, the “Nifty Fifty” market demise in the early 1970s was essentially the collapse in the “good buy-and-hold company stocks” everyone bought at the end of the 1960s!

By the early-1980s, after more than a decade of flat and volatile stock prices, market-timing was all the rage, just in time for a record-setting 20-year bull market run where only market-timers lost money! By the late 1990s, “buying and holding technology companies” was a sure thing. After all, we were in a “new-era” that would drive stocks higher forever! Today, after a decade of stock market blues and after the worst financial panic in the postwar era, “buy-and-hold” is again dead! Most believe the “world will never again be the same,” and investors should prepare for profiting from volatile and trendless markets by adopting strict “trading rules.” Anyone see a pattern here? Our guess is, after more than 10 years of market malaise, buy-and-hold may once again be on the cusp of proving a great investment strategy.

An Earnings-Driven, à la 1960s–Style Bull Market???We believe this stock market recovery will prove an “earnings-driven” event. Because of the excessive fears created during the

crisis, businesses became extremely lean and mean, and most now possess considerable profit leverage. This was already evident during the first two quarters of this year when earnings outpaced expectations primarily due to margin enhancements. Soon, as the recovery matures, companies will begin to mix improved top-line results with enhanced operating leverage to produce a pronounced, and perhaps prolonged, profit cycle!

An earnings-driven bull market is not something most contemporary investors have experienced! Since interest rates and inflation peaked in 1980, bull markets have been driven by chronically declining interest rates and expanding price-earnings multiples (or chronic valuation-driven markets). However, since short-term rates are zero and long-term yields are close to record lows, an interest rate-driven stock market is not in the immediate future. Fortunately, earnings appear set for a significant period of growth.

Is there a precedent for an “earnings-driven stock market from average valuations”? Yes! The price-earnings multiple was average to above average throughout the 1960s decade, and yet despite no push from improved valuation, the stock market persistently rose in-line with earnings. Then, as now, both inflation and interest rates were very low and stayed dormant during much of the 1960s. Also, the price-earnings multiple was only average and stocks still managed a solid run in-line with corporate profits. To be sure, there are many, many differences between today and the early-1960s (e.g., debt is lower, savings is higher, and domestic demographics is younger, but there was also no “emerging world,” no surge in free-market capitalism breaking around the globe over the previous decade, and not nearly as much “dry powder cash” parked on the sidelines as today), but the crucial similarities of earnings growth potential, stable price inflation, and low interest rates do present some potential similarity. While the next few years will not be exactly like the 1960s, the possibility of another earnings-driven stock market is worth consideration.

Stay Bullish!!!The economy has just exited recession and the stock market rally is not likely to end this early in a fresh economic recovery. Policy officials have yet to begin reversing easing policies, positive job creation has yet to start, consumer confidence is only back to previous recession lows, and corporate profits have just begun to improve. Interest rates are still too low for an economy about to again embark on solid real growth. There is still too much pessimism, too many widespread doubts about the recovery, and a strong consensus belief in a potential double-dip recession. And, because of these fears, there is still too much cash on the sidelines.The stock market may already be up significantly from its crisis low in early March but is still probably far below the peak it will ultimately reach during the unfolding economic recovery.

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James W. Paulsen, Ph.D.Chief Investment Strategist, Wells Capital Management

Economic & Market Perspective

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The aggressive policy response to this crisis has created widespread future inflation angst. As illustrated in the top chart, the annual M2 money supply has risen about 8 percent in the last year—a strong pace by long-term historical standards. However, the four-year annualized growth in the M2 money supply remains much more modest and appears much less worrisome. While money supply growth in the last year is comparable to the high inflation in the 1970s, it also is no stronger than earlier this decade! Whether the response of monetary officials to this crisis leads to an eventual inflation problem depends on many factors (e.g., speed and strength of the recovery, global growth, dollar weakness, Fed responses, and bond vigilante reaction, to highlight a few). A primary

factor will certainly be whether the surge in money growth during the last year proves temporary and is quickly reversed or whether it becomes imbedded and raises the long-term monetary growth rate (dotted line). The lower chart shows the relationship between money growth and inflation is far from perfect. The U.S. has experienced several prolonged periods during the last 120 years where monetary growth was excessive, and yet material inflation did not materialize. No doubt inflation risk has been elevated by very accommodative policies and will demand ongoing consideration as the economic recovery matures. At this point, however, a significant rise in inflation is far from certain!??

M2 Money Supply GrowthAnnual Growth Rate (Solid)

4-Year Average Annualized Growth Rate (Dotted)

Monetary Worry!??!

Inflation vs. Money Supply GrowthAnnual Consumer Price Inflation Rate (Solid)Annual Growth in M2 Money Supply (Dotted)

September 2009

Five key forces are likely to produce an economic recovery that continues to outpace consensus expectation. First, the policy response to this crisis has been massive and most of it introduced only since the Lehman collapse one year ago. Economic policies have various lag times (average is about one year) before they begin to show economic impact. Consequently, favorable impact from the aggressive policy stimulus is just now beginning to show up on Main Street. Second, U.S. businesses have been preparing for the second

coming of the Great Depression by purging inventories, payrolls, and capital spending programs. If, rather than a depression, a U.S. recovery is unfolding, businesses will be forced to engage in a lot of “purge reversals”—rebuilding inventories, rehiring workers, and recommitting to projects earlier canceled. Third, although confidence has improved from when depression fears were widespread earlier this year, it should still rise substantially more as the recovery matures!

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Five Reasons to Expect “Better–than–Expected” Growth!?!?

Trailing 12-Month Federal DeficitBillions U.S. Dollars

Annual Growth in M2 Money Supply

Change in Real Business Inventories NonFarm Payroll Employment New Orders for Capital Goods

Conference Board Consumer Confidence IndexNatural Log Scale

Economic & Market Perspective

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“Better–than–Expected” Growth ... Continued!!??

Single Family U.S. Housing Starts

Total Annualized U.S. Auto Sales

Fourth, the housing and auto sectors have been chronically “subtracting” from U.S. growth for much of the last couple of years. Even if these two sectors simply bottom, it will “add” to overall real GDP growth via “addition by less subtraction”! More likely, as these charts suggest, housing and autos will likely expand some in the coming year, directly adding to overall growth. Finally, two negative forces—rising mortgage rates and surging energy prices—that could have

been problematic for the recovery, have stalled in the last few months, even though economic reports have improved. The longer these two negatives remain range bound, the more time this recovery can mature, gain strength, and achieve solid footing. Massive policy stimulus, the corporate purge reversal, improving economy-wide confidence, a bottoming in housing and autos, and the muting of negative forces should allow real GDP growth to surpass expectations in the coming year!??!

Crude Oil Futures Price

Bankrate’s National Average 30-Year Mortgage

September 2009

In our view, it is too early to evaluate whether the U.S. consumer is responding to stimulus and will soon spend again, or whether they will simply enhance savings and lower debt burdens. Many are looking at contemporary reports on consumer spending as evidence the consumer is dead and will not be a force for growth in this recovery. Why, though, should current spending trends be positive when job losses are still pronounced and private income trends are still contracting? We do not expect to see robust, or even moderately healthy, consumer spending “until” job creation returns. As these charts show, consumer spending has actually been stronger than expected considering the collapse in job creation. Historically, real consumption growth has been about 2 to 3 percent faster than job growth. In the last six months, however, even

though jobs have declined at an annualized rate of about 5 percent, real consumption has risen slightly! While this does not prove the U.S. consumer is healthy and robust, it also doesn’t suggest they are DOA! We are also encouraged by the response of household spending to “good deals.” The Cash for Clunkers program and housing sales based on falling foreclosure prices suggest the rumors of household death may be greatly exaggerated! Perhaps the U.S. consumer will prove very lethargic in the coming recovery. Perhaps not! We believe a couple of quarters of positive real GDP growth and a return to job creation will be necessary before judgment on the future of U.S. households can be accessed. And, we suspect many will again be surprised by the revival in the old “spendy culture” of the U.S. consumer?!?!

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Too Early to Evaluate the Consumer!???

Real Consumer Spending Growth vs. Job GrowthAnnualized 6-Month growth in real personal consumption expenditures (Solid)

Annualized 6-Month growth in nonfarm payroll employment (Dotted)

Real Consumption Growth Less Job Growth6-Month Annualized Growth Differential

Economic & Market Perspective

“Half-Empty” ... OR ... “Half-Full”!!??

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Best News for Jobs ... PROFITS!!?It takes profits to produce jobs and profits have again been rising! Total U.S. corporate profits have risen in each of the first two quarters this year at almost a 23 percent annualized pace! The solid line in this chart shows the profit per job which has risen by more than 14 percent since year-end!

Every time since at least 1960, when profit per job has risen by this much, nonfarm payroll employment has bottomed or was very close to a bottom. We expect profits to continue to rise in the next several quarters and therefore believe job creation will soon return?!??

Profit Per Job vs. NonFarm Payroll EmploymentN

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This crisis has produced a “half-empty” sentiment. While certainly there are significant headwinds and problems to worry over, there are also some surprisingly favorable trends

in the world that should be considered alongside the anxieties of the day. We offer this partial list of the day’s major concerns with some underappreciated newfound global assets!??

Most Seem Focused On:

• Overindebted/Undersaved U.S. Consumer?

• Aging Developed World Demographics?

• Leftward Shift in U.S. Politics/Economy?

• Only Average U.S. Equity Valuations?

• Fear/Lack of Animal Spirits?

• A Weak U.S. Dollar?

But Ignore:

• Newfound Oversaved/Low Debt Emerging World Consumers!

• Young Emerging World Demographics with Ballooning Desires!

• Surge in Free-Market Capitalism around the Globe in Last 10-15 Years!

• U.S. near Price Stability (core infl ation ~1 percent) with Record-Low Interest Rates!

• Massive “Dry Powder” on the Sidelines!

• An Improving U.S. Global Competitive Position!

September 2009

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It’s a Low, Low, Low Rate World!!!?U.S. interest rates are extraordinarily low. This may be appropriate if the world is indeed close to depression. However, it is worth considering how this page would look one year from now if the economy recovers and real GDP grows 3 to 4 percent! Borrowing propensities may currently be weak, but

if the economy starts to grow again and job creation returns, how long will borrowing remain anemic with an interest rate structure priced for a prolonged depression? How much and for how long can real GDP advance before this interest rate structure simply becomes absurd??? Just food for thought!!??

30-Year Conventional Mortgage Rate

U.S. Municipal Bond Yield**Bond Buyer 20 GO Bond Index

10-Year U.S. Treasury Bond Yield

Moody’s A Corporate Bond Yield

Economic & Market Perspective

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Cloning the U.S. Consumer!?!!For the last 10 years, the U.S. has been busy investing in the emerging world, attempting to manufacture newfound consumers that can carry global economic growth for the next generation. OK, this wasn’t a conscious effort, but the early results are nonetheless encouraging. Why are U.S. households so undersaved and overindebted? Partly because a large part of household spending in the last decade leaked abroad (through a ballooning trade deficit), and rather than creating jobs and income here, it did so in emerging worlds. Consequently, even though the U.S. consumer may be somewhat impaired after so many years of spending in excess of its income, newfound emerging world consumers may help take up the slack! Ten years ago, the U.S. dollar level of emerging world consumption was only slightly more than one-half that of the U.S. consumer. Today, the dollar spending of emerging world consumers is almost on par with U.S. households! Amazing!

The U.S. has essentially cloned itself in the emerging world! This new consumer force, however, is much younger with burgeoning desires, low debt, and high savings! Indeed, in recent years, U.S. dollar-based consumption from the emerging world has been growing more than twice as fast as consumption in the U.S. The lower chart challenges the widespread idea that consumers in this part of the world are not yet really a meaningful force. The share of total global U.S. dollar-based imports comprised by the emerging world “headliners” (i.e., China, India, and Mexico) has risen to about 11 percent—more than double its level one decade ago! Perhaps the U.S. consumer is no longer up to the task of leading global growth, but their “overspending” in recent years has created a brand new global asset (i.e., newfound emerging world consumers) which may be able to fill (or at least significantly reduce) the gap!???

Emerging World “Headliner” Imports as a Percent of Total World Imports*

*Imports from China, India, and Mexico as a percent of total world imports.

Total Private Consumption Expenditures in U.S. DollarsEmerging Market Economies* as a Percent of U.S.

Annual Growth in U.S. Dollar Total Private ConsumptionEmerging Economies* vs. U.S.

September 2009

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The U.S. Dollar Likely to Weaken against Emerging Country Currencies ... And it Should!!!!After surging on safe-haven demands during the worst of the crisis, the U.S. dollar has steadily weakened since the financial markets and the economy have shown increasing signs of recovery. In the top chart, the dotted line illustrates the trade-weighted U.S. dollar index against 10 of its largest developed trading partners. The dotted line is a Trade-Weighted emerging world U.S. dollar index. It is comprised by the 22 countries that are included in the Morgan Stanley Emerging Market Stock Index. Both currency measures have moved roughly together in the last decade, but not perfectly. The U.S. dollar strengthened against both until the early 2000s, then mostly weakened until the 2008 crisis spike and have weakened again since early 2009. However, U.S. dollar strength against developed world currencies peaked in early 2002, whereas the U.S. dollar did not peak against emerging currencies until late 2004! Moreover, while the developed world dollar index is currently close to breaking to new decade-lows, the emerging dollar index is actually higher today than it was in early 2002 when the developed U.S. currency index peaked! We think both businesses and investors should recognize how these two U.S. dollar exchange rate trends are changing. While the U.S. dollar probably will weaken further in the next few months, we expect developed world currencies to soon essentially (and unofficially) lock together. Most developed countries

have similar economic problems (e.g., overindebtedness, aging demographics, and in need of new sources of economic growth). None of them can, nor will, allow others to devalue and steal coveted growth. Consequently, pressure to maintain currency parity will soon effectively peg developed world currencies within a narrow band. However, we also believe most developed world currencies (including the U.S. dollar) will continue to devalue slowly during the next decade against emerging world currencies. Emerging countries possess stronger inherent growth possibilities and also have currencies that are mostly woefully and artificially undervalued. On average, since 2002, the emerging world U.S. dollar index has risen by almost 40 percent relative to the U.S. dollar developed world index. Therefore, emerging currencies are undervalued and are set to undergo a prolonged period of appreciation against the U.S. dollar (and other developed world currencies). The lower chart shows that the weakness in the emerging currency index between 2005 and 2008 was beginning to pay U.S. dividends. The trade deficit with emerging markets has been improving for the first time in more than a decade. Since this deficit is about $400 billion, renewed U.S. dollar weakness against these parts of the world could continue to add significantly to overall U.S. real GDP growth!??!

U.S. Trade-Weighted Emerging Market Dollar Index vs. U.S. Trade-Weighted Developed Country Index**The DXY Index based on largest 10 trading partners.

Current Weights:Emerging Market Currency Index

U.S. Emerging Markets** Trade Balance**Trailing 12-Month sum of monthly net exports with the 22 countries comprising the Morgan Stanley Emerging Market Stock Price Index.

Value is in Billions of U.S. Dollars

Brazil 4.56%China 31.62%Colombia 1.68%Egypt 0.88%Hungary 0.33%India 3.09%Indonesia 1.57%Korea 6.03%Mexico 26.96%Poland 0.47%Russia 2.83%South Africa 2.84%Taiwan 4.22%Chile 1.45%Czech Rep 0.28%Israel 2.58%Malaysia 2.97%Morocco 0.18%Peru 0.86%Philippines 1.17%Thailand 2.35%Turkey 1.07%

Economic & Market Perspective

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May “Buy–and–Hold” R.I.P.!??!The 2008 crisis killed the “buy-and-hold” mantra of investing! The buy-and-hold strategy has left investors with zero returns for more than a decade and has raised the popularity of “market-timing.” This popularity switch between buy-and-hold and market-timing is an old one. By the end of WWII after about 15 years of malaise in the U.S. stock market, very few investors even wanted to touch stocks! However, the country was on the cusp of the best buy-and-hold investment era in its history! By the end of the 1960s, nearly everyone bought “good company stocks” and simply held them. After

all, such an approach had worked well for almost two decades. However, the nation was on the doorstep of nearly 15 years, whereby the stock market would be flat and volatile! By the early 1980s, market-timing was all the rage, as was buying and holding tech stocks in 1999! Today, it is widely believed the “world will never again be the same” and “buy-and-hold” is dead! Our guess, however, is after more than 10 years of market malaise, buy-and-hold may once again prove a great strategy in the coming decade??!!

Relative Price of GoldPrice of Gold Divided by CRB Commodity Price Index

U.S. Stock MarketShown on a Natural Log Scale.

Both Gold and Oil Look too High!???

Relative Price of Crude OilPrice of Oil Divided by CRB Commodity Price Index

Oil has been popular throughout this decade and gold has recently become “the inflation solution for policy official crisis overeasing”! Who knows what these investments may

do in the next several years, but as these charts show, in relation to overall commodity prices, both gold and oil prices look very expensive!??!

September 2009

Right after the Lehman Collapse ... It Paid to Take Risk!!??Immediately “after” the Lehman crash one year ago, widespread bearishness spiked! However, as these charts suggest, within about one month after the Lehman collapse, the appropriate thing for investors to do was to adopt bullish investments. Some of the most cyclical stock sectors (e.g., technology, materials, small caps, and emerging market stocks) and aggressive investments (like commodities and junk bonds) began outpacing market returns in November of 2008! Often

when most perceive risk as being high, the reality is risk is actually low! The time to begin buying risk assets was when most were giving them away! A renewed bull market rally (led by risk assets) began almost coincidently as the worst crisis carnage finally hit Main Street! While the prospective return possibilities are no longer as great as they were last November, we still think risk assets offer investors solid prospects, in part because confidence is still low and fears are still elevated!??

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S&P 500 Information Technology SectorRelative Stock Price Performance

S&P 500 Materials SectorRelative Stock Price Performance

Morgan Stanley’s Emerging Market IndexRelative Stock Price Performance

CRB Raw Industrial Commodity Price IndexShown on a Natural Log Scale.

Russell 2000 Small Cap IndexRelative Stock Price Performance

Junk Bonds vs. Treasury BondsRatio of Relative Total Return Indexes*

*BarCap U.S. Corporate High Yield TR divided by BarCap U.S. Treasury 7-10 Year TR

Economic & Market Perspective

The solid line illustrates the relative price performance of stocks above bonds. The dotted line shows the total level of U.S. corporate profits. Over time, it should not be surprising that these two series tend to move together. Typically, as profits rise to new highs, so does the relative performance of stocks! From 1960 until 2000, U.S. profits achieved four major new all-time highs that were matched by four new all-time highs in the relative performance of the stock market (above bonds). However, in this decade, even though profits surged ahead to another new all-time high, the

relative performance of stocks compared to bonds did not! However, profits have bottomed in this recession at a level slightly above its previous cycle peak in 2000. That is, the long secular trend in profitability appears to be intact. Why has the relative performance of stocks seemingly become disconnected from corporate profit results? Excessive Fears? We don’t know the answer, but find this disconnect interesting. Is it a harbinger of bad times to come? Or, an indication of forthcoming potentially strong stock returns???!

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Stocks Need to “Catch Up” to Profits!???

Relative Stock/Bond Ratio vs. Real Corporate Profits*

Consumer Confidence vs. Stock Market Growth

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Rising Confidence Should Push Stock Prices Higher??!As this chart illustrates, stock prices and confidence tend to be closely related. Even though confidence throughout the economy has begun to improve, it still remains extremely low (only just now back to cycle lows during the last 40 years) and will

likely rise as the recovery matures. Since confidence still has considerable room for further improvement, so does the stock market!!! It won’t be a straight line, but stay Bullish!!!

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Will Velocity Turn???!Borrowing velocity (i.e., the rate at which money supply creates new borrowing) has fallen significantly in this recession. However, as the left chart shows, the depth and rate of decline in private-sector borrowing velocity is no worse in the contemporary crisis than it was during the 1970s. This velocity chart does not yet show any watershed shift in borrowing propensities, although an abnormal velocity recovery could certainly still come to pass. As illustrated in

the right chart, until the 1990s, money supply growth (dotted line) tended to lead borrowing growth. Since 1990, however, borrowing has led monetary growth. So, what will it be? Is the surge in the money supply in the last couple of years a precursor to a revival in borrowing (à la 1960 to 1990) or is the decline in borrowing (solid line) suggesting an impending collapse in the U.S. money supply? We’ll be watching?!?!?

| 15 |

Private-Sector Borrowing-Money Supply Velocity**Total Household and Business Sector Debt Outstanding divided by M2

Money Supply. Shown on a natural log scale.

Private Debt vs. Money SupplyAnnual Growth in Total Household and Business Debt (Solid)

Annual Growth in M2 Money Supply (Dotted)

Economic & Market Perspective

An Earnings-Driven, à la 1960s–Style, Bull Market???

Wells Capital Management (WellsCap) is a registered investment adviser and a wholly owned subsidiary of Wells Fargo Bank, N.A. WellsCap provides investment management services for a variety of institutions. The views expressed are those of the author at the time of writing and are subject to change. This material has been distributed for educational purposes only, and should not be considered as investment advice or a recommendation for any particular security, strategy or investment product. The material is based upon information the author considers reliable, but its accuracy and completeness cannot be guaranteed. Past performance is not a guarantee of future returns. As with any investment vehicle, there is a potential for profit as well as the possibility of loss. For additional information on Wells Capital Management and its advisory services, please view our web site at www.wellscap.com, or refer to our Form ADV Part II, which is available upon request by calling 415.396.8000.

Written by James W. Paulsen, Ph.D. 612.667.5489 | For distribution changes call 415.222.1706 | www.wellscap.com | ©2009 Wells Capital Management

We believe the unfolding recovery in the stock market will prove mostly an “earnings-driven” event. Due to excessive fears during this recession, businesses have become extremely lean and mean, focused on boosting efficiencies and enhancing productivities. Consequently, the business sector possesses considerable profit leverage. Is there a precedent for an “earnings-driven stock market from average valuations”? Yes! The stock market run during the 1960s! Then, as now, both inflation and interest rates were very low and stayed dormant during much of the 1960s. Also, the price-earnings multiple was only average, and yet still, the stock market managed a solid run in-line with corporate profits. In the top chart, the solid line is the S&P 500 stock price index and the dotted line is the level of trailing earnings per share. The chart is constructed so when the S&P 500 price line (the solid line) touches earnings (dotted line), the stock market is selling for 15 times trailing earnings. In the late 1950s, the S&P 500

traded at 15 times (an average valuation similar to today), and it traded at or above this level throughout much of the 1960s. Consequently, the 1960s stock market gains had little to do with valuation improvement, but rather was almost entirely tied to earnings growth. This was made possible because first, earnings grew, and second, both inflation and yields remained stable. Could this happen again in the developing recovery? We think so! Inflation typically declines for one or two years “after” a recession ends, which implies inflation should remain well-controlled during the next couple of years. Moreover, yields have already adjusted for no depression, and while they may rise some as recovery (real GDP growth) takes hold, they are not likely to rise significantly unless inflation surges. In the next few years, we expect inflation and yields to remain low and stable while earnings surprise to the upside perhaps producing a stock market rally à la 1960s-style??!!

S&P 500 Composite Stock Index Price vs. Earnings*1958–1970

S&P Stock Price Index shown on a natural log scale (Solid)Trailing 12-Month earnings per share, 3-Month moving average (Dotted)

10-Year Treasury Yield vs. Consumer Price Inflation1958–1970

U.S. 10-Year Treasury Yield (Solid)Annual U.S. Consumer Price Inflation Rate (Dotted)