march 17, 2011

market commentary global investment committee

Global Investment
Committee
Special Bulletin
analysis authors

unshaken jeff applegate

Chief Investment Officer

The forces driving the global economic expansion

will prevail. david m. darst, cfa
Chief Investment Strategist

Global equity and credit markets have been battered charles reinhard
Deputy Chief Investment Officer
by the tragic devastation in Japan and, prior to that,
the ongoing unrest in the Middle East and North
Africa (MENA). In the case of Japan, market
concerns have been focused on potential radiation
leakage from the damaged Fukushima Dai-Ichi
nuclear reactors. At this juncture, all expert opinion
has ruled out the possibility of an event comparable
to the Chernobyl reactor meltdown, which occurred
in 1986. Assuming that remains the case, the worst of
current market fears over this incident should soon
be behind us.
 market commentary / global investment committee

Indeed, the markets are already begin-
ning to refocus on the positive economic
impact of the rebuilding effort in the
stricken areas of northern Japan. This
pattern is in keeping with prior market
reactions to tragic, localized events such
as the Kobe and Haitian earthquakes,
Hurricane Katrina, Chernobyl or the East
Asian tsunami. None of those disasters
led to an interruption in US or global
GDP growth.
Meanwhile, unsettled conditions
in Libya and elsewhere in the Middle
East have led to heightened volatility
in crude-oil prices, which have ranged
between $85 and $105 per barrel in the
last month. As long as this political tur-
moil doesn’t spread to MENA’s primary

Table 1: Morgan Stanley and Citi Global GDP and Inflation Forecasts
(year-over-year percent change)
% Contribution % Contribution
Morgan Stanley to Growth Citi to Growth
2010 2011 2012 2011 2010 2011 2012 2011
Global GDP 4.9 4.4 4.6 Global GDP 4.0 3.7 3.8
Developed Economies 2.7 2.5 2.7 30 Developed Economies 2.5 2.4 2.4 45
US 2.8 3.3 3.5 15 US 2.9 3.1 3.3 22
Euro Zone 1.7 1.5 1.7 5 Euro Zone 1.6 1.7 1.4 10
UK 1.3 1.4 2.0 1 UK 1.4 2.3 2.2 2
Japan 3.9 2.0 1.9 3 Japan 3.9 1.7 1.9 4
Developing Economies 7.5 6.4 6.6 70 Developing Economies 7.0 6.2 6.2 55
Brazil 7.5 4.0 5.0 3 Brazil 7.6 4.8 4.5 4
Russia 4.0 5.0 4.5 3 Russia 4.0 4.0 4.0 2
India 8.7 7.7 8.7 9 India 8.4 8.6 8.9 5
China 10.3 9.0 9.0 27 China 10.3 9.2 9.0 25
Global Consumer Prices Global Consumer Prices
Global Inflation 3.3 3.9 3.2 Global Inflation 2.7 3.5 3.1
Developed Economies 1.4 2.3 1.9 Developed Economies 1.4 2.2 1.8
Developing Economies 5.4 5.5 4.6 Developing Economies 5.2 6.1 5.4
US Core 1.0 1.4 2.1 US Core 1.0 1.2 1.4
US CPI 1.6 2.9 2.4 US CPI 1.6 2.2 1.4

Note: Morgan Stanley regional and global forecasts are GDP-weighted averages, using Purchasing Power Parity estimates. That gives greater weights
to developing economies. Citi forecasts use current foreign exchange rates.
Source: Morgan Stanley Economics, Citi Investment Research & Analysis, Morgan Stanley Smith Barney as of March 11, 2011

2 morgan stanley smith barney | march 17, 2011 Please refer to important information, disclosures and qualifications at the end of this material.
 market commentary / global investment committee
oil-producing nations, and thus cause
a sharp spike in oil prices, this fairly
range-bound oil-price volatility should
not pose a threat to global business-
cycle expansion or, by extension, the
global equity bull cycle. Indeed, in our
base-case economic assumptions for
this year and next, we have assumed oil
prices will average $100 and $105 per
barrel, respectively.
GROWTH LIFTS OIL PRICES. That demand-
driven view on oil prices is mainly a
function of continued strong growth in
emerging market (EM) economies. In
aggregate, we expect those economies
to grow in excess of 6%, both in 2011
and in 2012 (see Table 1, page 2). Their
growth is also more resource intensive
than that of developed-market (DM)
economies, where we expect growth of
closer to 2% each year for the same two
years. Of the primary DM economies,
Japan’s growth will likely be 2% per year,
Europe only 1% and, in the US, excess of
3% each year. The Euro Zone’s growth
prospects will likely remain challenged,
in part due to the fiscal policy tightening
that is likely as the region deals with its
debt crisis and in part due to tighter
credit from the European Central Bank,
probably starting this spring.
By contrast, the US will likely enjoy the
3 morgan stanley smith barney | march 17, 2011
strongest growth among DM countries
for two reasons: Monetary policy remains
highly stimulative and the economy ap-
pears to be successfully transitioning
to a self-sustaining growth mode. The
Federal Reserve reaffirmed this week
that it will not begin to exit Quantita-
tive Ease until July at the earliest, as
originally planned. Moreover, we don’t
think that the Fed will boost policy rates
until 2012, when Fed officials are likely
to be more certain that the US economy
is on firm footing.
Current Fed policy has led to a nega-
tive “real,” or inflation-adjusted, federal
funds rate. In the past, similar condi-
tions have been able to revive economic
growth by creating powerful incentives
to move out of cash and into other in-
vestments and expenditures. Through
holding down short-term rates, the Fed
has concomitantly created a steep yield
curve in which longer-maturity yields
exceed shorter ones. The steepness of
the curve is a useful leading economic
indicator, and it currently points to con-
tinued profits growth.
STRONG EARNINGS GROWTH. The most
recent profit reports are telling. With
nearly all Standard & Poor’s 500 firms
now having reported fourth-quarter
results, revenues are up 8% and profits
Please refer to important information, disclosures and qualifications at the end of this material.
are 34% above year-ago levels. Strategists
at Morgan Stanley and Citi, as well as
within the broader analyst community,
expect earnings-per-share (EPS) growth
of 9% to 15% this year, with slightly slower
EPS growth in 2012.
Meanwhile, in February the US un-
employment rate fell to 8.9%, its lowest
level in two years, signifying the fastest
pace of job creation in almost a year. This
improvement underscores Federal Re-
serve Chairman Ben Bernanke’s “grounds
for optimism” comments in his recent
testimony to Congress. Importantly,
this new hiring does not seem to have
affected productivity growth. Given the
severity of the Great Recession, the first
stage of the ensuing recovery has posted
the highest early stage US productiv-
ity readings in 50 years. Productivity
growth is what generates higher living
standards over time, and such progress
continues to underpin the impressive
rebound in corporate profits.
LONG-TERM PERSPECTIVE. Growth is
the best way for a country to lower a
high debt-to-GDP ratio. This ratio, cur-
rently at 66%, is at its highest point since
1950 when the US was still working off
its World War II debt. In fact, following
World War II, political and business
leaders worried that the economy would
 market commentary / global investment committee
slip back into depression as war-relat-
ed stimulus ended. At the time, many
wondered how the country would pay
down its debt without those soldiers
who never returned home from the war
to reenter the work force. In our view,
current worries about recession when
the stimulus expires or about the gov-
ernment debt overhang do not appear
any greater than challenges overcome
in the past.
The period between World War II and
the late 1960s was one of high productiv-
ity and low inflation, which gave a boost
to stock prices. US equities generated a
compound average annual return of 14%
from 1946 to 1968. During those years,
inflation was about 3% on average and
equities performed 11% per year above
inflation. We believe that the US economy
is today in another high-productivity,
low-inflation environment.
MODEST VALUATION. Another reason
we expect equity market returns that
are better than those of the dual bear
markets of the first decade of this century
is that global equities are trading at a
forward P/E ratio near 13—at the lower
end of their 50-year historical range.
The global equity dividend yield is also
historically high when compared with
yields on sovereign bonds and cash. As
4 morgan stanley smith barney | march 17, 2011
a result, we consider global equities to
be attractively valued in absolute and
relative terms. In our base case, we ex-
pect valuations to remain unchanged.
The pace of earnings growth should
therefore provide reasonable guidance
for equity returns.
POSITIVE ON RISK ASSETS … As the global
economy expands, we continue to evalu-
ate whether to reduce our risk exposure.
Our analyses suggest that many risk as-
sets—equities, corporate bonds, REITs
and commodities—remain attractive
relative to most safe-haven asset classes
such as cash and DM sovereign debt.
As a result, our asset allocation models
overweight global equities and alterna-
tive/absolute return investments and
underweight positions in government
bonds and cash. Within global equi-
ties, our models remain tactically OW
to emerging markets. The rationale is that
emerging markets have strong financial
conditions, robust growth characteristics
and potential currency appreciation.
We are also OW commodity-sensitive
regional equity markets, specifically
Canada and Asia Pacific ex Japan; the
former has more exposure to energy,
while the latter, which includes Australia,
provides more exposure to mining and
raw materials. In January, within DM
Please refer to important information, disclosures and qualifications at the end of this material.
equities, we increased our allocation
to US stocks and went further UW in
Europe and Japan. In the US, we favor
growth at the style level.
… AND ON CORPORATE CREDIT. Within
global fixed income, our portfolios are
tilted toward high-grade and high yield
corporate debt—which offer attractive
spreads over government debt—and away
from DM sovereign debt. Corporate bonds
also offer high returns versus inflation.
US investors who can benefit from tax-
free income may consider municipal
bonds in lieu of corporate bonds. Because
longer-maturity debt offers significantly
higher yields than shorter maturities, we
remain underweight in short-duration
instruments and cash.
A growing global economy, featur-
ing robust economic advancement in
EM countries, should spur demand for
commodities. An upturn in economic
fundamentals likely will improve the
supply/demand balance for commercial
real estate. The Fed’s unprecedented
commitment to higher inflation will
likely succeed. As a result, our portfo-
lios have tactical OW positions in three
alternative/absolute return investments:
commodities, REITs and inflation-
linked securities.
 market commentary / global investment committee

Index Definitions
STANDARD & POOR’S 500 indexThis
capitalization-weighted index comprises 500
leading companies in leading industries of the
US economy.

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5 morgan stanley smith barney | march 17, 2011 Please refer to important information, disclosures and qualifications at the end of this material.
 market commentary / global investment committee

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Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business
around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected.
Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valua-
tions, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations.
Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and
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