Dublin, Ireland May 2007
GIC ABROAD IN IRELAND GLOBAL STOCK MARKETS, VALUATION AND OUTLOOK Martin Barnes
Managing Editor Bank Credit Analyst
THINGS TO WORRY ABOUT
• Geopolitics • Oil • U.S. Housing • Trade Imbalances • Financial Accidents
THINGS TO BE REASSURED ABOUT
• Growth is better balanced globally • Inflation is low • Corporate sector finances are healthy • Liquidity is plentiful for financial assets • Equity valuations are reasonable
GOOD GROWTH AND LOW INFLATION Ann% Chg
GLOBAL REAL PER CAPITA GDP* (LS) CORE** CONSUMER PRICES (RS)
Ann% Chg
14
3 10
2
6
1
2 © BCA Research 2007
1975
1980
1985
1990
1995
* SHOWN AS A 5-YEAR MOVING AVERAGE; SOURCE: IMF ** EXCLUDING FOOD AND ENERGY; SOURCE: OECD
2000
2005
A FAVORABLE MONETARY ENVIRONMENT Ann% Chg
8
Ann% Chg
G7 BROAD MONEY GROWTH
8
6
6
4
4
Ann% GLOBAL FOREIGN EXCHANGE Chg RESERVES
Ann% Chg
20
20
10
10
0
0
© BCA Research 2007
1996
1998
2000
2002
2004
2006
AN EARNINGS-DRIVEN BULL MARKET
MSCI GLOBAL EQUITY PRICE INDEX* GLOBAL EARNINGS**
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0 © BCA Research 2007
1994
1996
1998
2000
2002
2004
2006
*SOURCE: MORGAN STANLEY CAPITAL INTERNATIONAL; INDEXED TO 1 IN MARCH 2003 **INDEXED TO 1 IN MARCH 2003
MARKET PERFORMANCES AND VALUATIONS HAVE CONVERGED %
%
60
DISPERSION OF GLOBAL EQUITY MARKET RETURNS*
60
40
40
20
20
%
%
STANDARD DEVIATION OF GLOBAL P/E RATIOS**
50
50
40
40
30
30
20
20 © BCA Research 2007
1998
2000
2002
2004
2006
* MAXIMUM MONTHLY RETURN MINUS MINIMUM; INCLUDES 24 MARKETS ** STANDARD DEVIATION OF 12-MONTH FORWARD PERs FOR 24 MARKETS
RELATIVE STOCK PERFORMANCE TWO BIG WINNERS
TWO BIG LOSERS
1.1
RELATIVE STOCK PRICES: U.S./WORLD
1.1
RELATIVE STOCK PRICES:
1.5
1.5
EMU/WORLD
1.0
1.0
1.4
1.4
.9
.9
1.3
1.3
1.2
1.2
.42 .40 .38 .36 .34 .32
JAPAN/WORLD
.42 .40 .38 .36 .34 .32
© BCA Research 2007
2003
2005
2007
.16
EMERGING MARKETS/ WORLD
.16
.14
.14
.12
.12
.10
.10 2003
2005
2007
VALUATIONS ARE REASONABLE EVERYWHERE 12-MONTH FORWARD P/E:
24
40 12-MONTH FORWARD P/E: 40
20
20
30
30
16
16
20
20
24
24
U.S.
EMU
20
16
EMERGING MARKETS
16
20
16 12
24
JAPAN
16 © BCA Research 2007
12
2000 2002 2004 2006 SOURCE: THOMSON FINANCIAL / IBES
12
12
8
8
2000 2002 2004 2006
EQUITIES ARE ATTRACTIVE VERSUS BONDS %
8
REAL G7 10-YEAR BOND YIELD GLOBAL FORWARD EARNINGS YIELD
%
8
6
6
4
4
2
2
2
GLOBAL EARNINGS YIELD RATIO*
1
2 STOCKS EXPENSIVE
0
0 -1 -2
1
STOCKS INEXPENSIVE © BCA Research 2007
1990 1992 1994 1996 1998 2000 2002 2004 2006 * REAL G7 10-YEAR BOND YIELD MINUS GLOBAL FORWARD EARNINGS YIELD; STANDARDIZED
-1 -2
THREE PILLARS OF THE U.S. EQUITY BULL MARKET Ann% Chg
Ann% Chg CORE* PCE INFLATION
8 6 4 2 %
12 10 8 %
60 50 40
8 6 4 2 %
AFTER-TAX CORPORATE PROFITS AS A % OF GDP
12 10 8 %
HOUSEHOLD EQUITIES AS A % OF PORTFOLIOS
© BCA Research 2007
1980
1985
1990
* CORE EXCLUDES FOOD AND ENERGY
1995
2000
2005
60 50 40
DECOMPOSING EQUITY MARKET RETURNS Average Annual % Change Historical Past Optimistic Status quo Bear Average Decade Scenario* Scenario** Scenario*** 1950-95 1996-2006 2006-16 2006-16 2006-16 Nominal GDP
7.6
5.4
5.0
5.0
5.0
Earnings
6.7
9.0
5.0
4.5
4.0
+ Valuation change
2.3
0.8
2.0
0.0
-2.0
= Growth in S&P 500
9.0
9.8
7.0
4.5
2.0
+ Reinvested dividends
4.2
1.8
1.8
1.8
1.8
= Total equity
13.2
11.6
8.8
6.3
3.8
returns
4.2
2.6
2.0
2.0
2.0
Inflation (CPI)
8.6
8.8
6.7
4.2
1.8
Real returns * Assumes that the forward price-earnings ratio rises to 18 over the period ** Assumes that the price-earnings ratio remains at its current level near 15. *** Assumes that the price-earnings ratio falls to 12 over the period.
TIGHTER MONEY LEADS TO LOWER EQUITY MULTIPLES
30
S&P 500 P/E RATIO BASED ON OPERATING EARNINGS
30
20
20
10
10
%
%
18
FED FUNDS RATE
18
14
14
10
10
6
6
2
2
© BCA Research 2007
1965
1975
1985
1995
NOTE: SHADING DENOTES PERIODS OF RISING FED FUNDS RATE
2005
EQUITY PERFORMANCE AND PROFIT MARGINS: NOT WHAT YOU WOULD EXPECT 1200 800 400 200 30
S&P 500 INDEX
Multiples have risen when margins contracted
S&P 500 P/E RATIO BASED ON OPERATING EARNINGS
1200 800 400 200 30
20
20
10
10
%
20
%
TOTAL PRE-TAX ADJUSTED* PROFITS AS A % OF CORPORATE SECTOR GDP
20
16
16
12
© BCA Research 2007
1982
1986
1990
1994
1998
2002
*ADJUSTMENTS INCLUDE INVENTORY VALUATION AND DEPRECIATION NOTE: SHADED AREAS CORRESPOND TO FALLING PROFIT MARGINS
2006
12
CEOs FAVORING STOCKS Bn$
Bn$ U.S.:
NET EQUITY ISSUANCE NET CORPORATE BOND ISSUANCE
500
500
0
0
-500
-500
© BCA Research 2007
1990
1992
1994
1996
1998
2000
2002
NOTE: ALL SERIES BASED ON THE NON-FINANCIAL AND FINANCIAL CORPORATE SECTORS
2004
2006
PRIVATE EQUITY AND M&A ARE ON THE RISE IN EMERGING MARKETS TOO Bn US$
Bn US$
GLOBAL M&A AND PRIVATE EQUITY FLOWS TO:
140
G7 (LS) EMERGING MARKETS (RS)
120
800
100 600 80 400
60 40
200 © BCA Research 2007
2004
2005
2006
2007
EMERGING MARKETS EQUITY WEIGHT WILL GROW %
%
20
20
15
15
10
EMERGING MARKET MARKET CAP AS A % OF GLOBAL* EMERGING MARKET GDP AS A % OF GLOBAL**
5
5 © BCA Research 2007
1990
10
1995
* SOURCE: DATASTREAM **SOURCE: IMF
2000
2005
EMERGING MARKETS: EQUITY FACTOR RANKING*
Potential leaders
11 10 9
Solid gains to be expected
Potential laggards
8 7 6 5 ZIL ESIA KEY AND ARY REA AND HINA INES WAN YSIA TINA HILEXICO SSIA ECH RICA NDIA A I BR DON TUR POL UNG KO HAIL C LIPP TAI ALA GEN C ME RU CZ . AF I S H T M AR IN PH * BASED ON A COMBINATION OF VALUATION, GROWTH, LIQUIDITY AND MOMENTUM
MARKET ATTRACTIVENESS SCORES
Emerging Markets
Valuation 2
Earnings potential 3
Liquidity 3
Total 8
Japan
3
0
1
4
Euro Area
2
-2
0
1
U.S.
0
1
-2
-1
U.K.
1
-1
-2
-2