Download 2009 estimate - Global Insight

Alaska Senate Finance Committee
Market & Economic Review
2009 Capital Market Projections
APFC Performance
February 2009
Michael J. O’Leary CFA
Executive Vice President
Prepared 2-03-09
Callan Associates  Knowledge for Investors
Fourth quarter overview
 Terrible market environment for all major asset classes
 Credit markets froze around the world
 Extraordinary governmental policy actions initiated quickly
but not as rapidly as many had hoped
 Flight to quality resulted in sharp declines in short-term
government rates and increases in “risk” premiums.
 Commodity prices fell sharply as expectations regarding
the length and depth of economic slowdown mounted
 U.S. dollar strengthened significantly hurting profits for
multinationals, unhedged international investors and
returns on international investments for U.S. based
investors.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
1
Second Half of 2008: Startling Period





Fannie Mae and Freddie Mac placed into conservatorship.







Washington Mutual seized by regulators, assets sold to JP Morgan.
Lehman Brothers declared bankruptcy.
AIG rescued by government.
Merrill Lynch sold to Bank of America.
Morgan Stanley and Goldman Sachs convert to bank holding companies, voluntarily
placing themselves under the regulatory oversight of the Fed.
$750 billion rescue plan passed.
Money market funds “break the buck” for the first time.
Oil drops by $100/barrel, commodity prices cool.
Wachovia bought by Wells Fargo.
U.S. and other sovereign governments make direct investments in banks.
Nowhere to hide - virtually all asset classes except nominal Treasury bonds
suffer steep declines.
 Housing market remains locked in a death spiral.
 Global economies follow the U.S. into deep recession.
Timeline from Principal Global Investors
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
2
U.S. Fixed Income
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
3
The Capital Markets
What a Difference One Year Can Make
Average Annual Return
Five Years Five Years Ten Years Ten Years Fifteen Years Fifteen Years
2003-07
2004-08
1998-07
1999-08
1993-07
1994-08
2003
2004
2005
2006
2007
2008
Broad U.S. Stock Market
Russell 3000
S&P Super Composite 1500
31.06
29.59
11.95
11.78
6.12
5.66
15.72
15.34
5.14
5.47
-37.31
-36.72
13.63
13.23
-1.95
-1.89
6.22
6.35
-0.80
-0.76
10.49
10.66
6.36
6.59
Large Cap U.S. Stocks
Russell 1000
S&P 500
29.89
28.80
11.40
10.88
6.27
4.91
15.46
15.79
5.77
5.49
-37.60
-37.00
13.43
12.83
-2.04
-2.19
6.20
5.91
-1.09
-1.38
10.58
10.49
6.47
6.46
Small Cap U.S. Stocks
Russell 2000
S&P 600 Small Cap
47.25
38.79
18.33
22.65
4.55
7.68
18.37
15.11
-1.57
-0.30
-33.79
-31.07
16.25
16.04
-0.93
0.88
7.08
9.03
3.02
5.18
10.10
11.78
5.89
7.80
Non-U.S. Stock Markets
EAFE ($US)
MSCI Emerging Markets
38.59
56.28
20.25
25.95
13.54
34.54
26.34
32.59
11.17
39.78
-43.38
-53.18
21.59
37.46
1.66
8.02
8.66
14.53
0.80
9.31
9.56
12.16
3.52
2.73
Fixed Income Markets
LB Aggregate
Citi Non-US Bonds
4.10
18.52
4.33
12.14
2.43
-9.21
4.33
6.95
6.97
11.45
5.24
10.11
4.42
7.54
4.65
5.97
5.97
6.30
5.63
5.59
6.47
6.79
6.18
6.47
Cash Market
90-day T-bill
1.15
1.33
3.07
4.85
5
2.06
3.07
3.25
3.77
3.45
4.09
4.02
Inflation
CPI-U*
1.88
3.26
3.42
2.54
4.08
0.09
3.03
2.67
2.67
2.51
2.64
2.47
* Annual CPI-U data are measured as year-over-year change.
 Results for 2008 substantially reduce equity returns across all periods.
 Five-year returns through 2007 were very robust for equity, now they are negative.
Ten-year results are weak as the tech bubble years continue roll out of the
calculations. Fifteen-year results are now weak, and roughly on par with those of fixed
income.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
4
Real Estate
NCREIF Returns
8%
6%
4%
Return
2%
0%
-2%
-4%
Total Return
-6%
Income Return
-8%
Capital Return
-10%
2009 Capital Market Projections
2005
2006
2007
2008
2001
2002
2003
2004
1997
1998
1999
2000
1993
1994
1995
1996
1990
1991
1992
1986
1987
1988
1989
1982
1983
1984
1985
1978
1979
1980
1981
-12%
Callan Associates  Knowledge for Investors
5
The Capital Markets
What a Difference One Year Can Make
Average Annual Return
Five Years Five Years Ten Years Ten Years Fifteen Years Fifteen Years
2003-07
2004-08
1998-07
1999-08
1993-07
1994-08
2003
2004
2005
2006
2007
2008
Broad U.S. Stock Market
Russell 3000
S&P Super Composite 1500
31.06
29.59
11.95
11.78
6.12
5.66
15.72
15.34
5.14
5.47
-37.31
-36.72
13.63
13.23
-1.95
-1.89
6.22
6.35
-0.80
-0.76
10.49
10.66
6.36
6.59
Large Cap U.S. Stocks
Russell 1000
S&P 500
29.89
28.80
11.40
10.88
6.27
4.91
15.46
15.79
5.77
5.49
-37.60
-37.00
13.43
12.83
-2.04
-2.19
6.20
5.91
-1.09
-1.38
10.58
10.49
6.47
6.46
Small Cap U.S. Stocks
Russell 2000
S&P 600 Small Cap
47.25
38.79
18.33
22.65
4.55
7.68
18.37
15.11
-1.57
-0.30
-33.79
-31.07
16.25
16.04
-0.93
0.88
7.08
9.03
3.02
5.18
10.10
11.78
5.89
7.80
Non-U.S. Stock Markets
EAFE ($US)
MSCI Emerging Markets
38.59
56.28
20.25
25.95
13.54
34.54
26.34
32.59
11.17
39.78
-43.38
-53.18
21.59
37.46
1.66
8.02
8.66
14.53
0.80
9.31
9.56
12.16
3.52
2.73
Fixed Income Markets
LB Aggregate
Citi Non-US Bonds
4.10
18.52
4.33
12.14
2.43
-9.21
4.33
6.95
6.97
11.45
5.24
10.11
4.42
7.54
4.65
5.97
5.97
6.30
5.63
5.59
6.47
6.79
6.18
6.47
Cash Market
90-day T-bill
1.15
1.33
3.07
4.85
5
2.06
3.07
3.25
3.77
3.45
4.09
4.02
Inflation
CPI-U*
1.88
3.26
3.42
2.54
4.08
0.09
3.03
2.67
2.67
2.51
2.64
2.47
* Annual CPI-U data are measured as year-over-year change.
 Results for 2008 substantially reduce equity returns across all periods.
 Five-year returns through 2007 were very robust for equity, now they are negative.
Ten-year results are weak as the tech bubble years continue roll out of the
calculations. Fifteen-year results are now weak, and roughly on par with those of fixed
income.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
6
Second Half of 2008: Startling Period





Fannie Mae and Freddie Mac placed into conservatorship.







Washington Mutual seized by regulators, assets sold to JP Morgan.
Lehman Brothers declared bankruptcy.
AIG rescued by government.
Merrill Lynch sold to Bank of America.
Morgan Stanley and Goldman Sachs convert to bank holding companies, voluntarily
placing themselves under the regulatory oversight of the Fed.
$750 billion rescue plan passed.
Money market funds “break the buck” for the first time.
Oil drops by $100/barrel, commodity prices cool.
Wachovia bought by Wells Fargo.
U.S. and other sovereign governments make direct investments in banks.
Nowhere to hide - virtually all asset classes except nominal Treasury bonds
suffer steep declines.
 Housing market remains locked in a death spiral.
 Global economies follow the U.S. into deep recession.
Timeline from Principal Global Investors
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
7
APFC Calendar Period Performance
Returns
for Calendar Years
8 Years Ended December 31, 2008
Group: CAI Public Fund Sponsor Database
40.0
20.0
A (60)
A (62)
A (36)
A (41)
A (29)
0.0
A (27)
A (21)
(20.0)
A (55)
(40.0)
10th Percentile
25th Percentile
Median
75th Percentile
90th Percentile
APFC
A
2008
2007
2006
2005
2004
2003
2002
2001
(19.84)
(22.66)
(25.27)
(27.14)
(29.71)
10.87
9.57
8.20
6.86
6.15
15.76
15.05
14.04
12.29
10.37
9.34
8.61
7.54
5.86
4.23
13.13
12.31
11.47
10.17
8.26
26.12
23.99
21.14
19.68
14.55
(3.07)
(5.96)
(8.26)
(9.52)
(11.46)
0.20
(1.79)
(3.46)
(5.38)
(6.67)
(25.70)
8.90
13.63
8.46
11.83
20.59
(5.39)
(1.85)
Please note returns are preliminary. Background data for other public funds may be
distorted owing to valuation policies regarding illiquid investments. APFC returns include
current estimates for real estate (with 1 exception). Many others lag such returns by ¼ year.
2009 Capital Market Projections
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8
Stock Market Returns by Calendar Year
2008 Performance in Perspective - History of the U.S. Stock Market
218 Years of Returns
2008 return =
negative 37.0%
1931
1807
-50%
2009 Capital Market Projections
2008
1937
1801
-40%
2002
1974
1930
1917
1907
1857
1854
-30%
Callan Associates, Inc.
2001
1973
1957
1926
1920
1903
1893
1884
1876
1858
1842
1841
1839
1836
1810
-20%
2000
1990
1981
1977
1969
1966
1962
1946
1941
1940
1932
1914
1913
1910
1890
1887
1883
1877
1873
1869
1859
1853
1838
1837
1831
1828
1825
1819
1812
1811
1797
1796
1795
1792
-10%
2007
2005
1994
1992
1987
1984
1978
1970
1960
1956
1953
1948
1947
1939
1934
1929
1923
1916
1912
1911
1906
1902
1896
1895
1894
1892
1889
1888
1882
1881
1875
1874
1870
1867
1866
1864
1851
1849
1848
1847
1846
1833
1827
1826
1822
1816
1815
1805
0%
2006
2004
1993
1988
1986
1972
1971
1968
1965
1964
1959
1952
1942
1921
1909
1905
1900
1899
1891
1886
1878
1872
1871
1868
1865
1861
1855
1845
1844
1840
1835
1829
1824
1823
1821
1820
1818
1813
1806
1803
1802
1793
1791
10%
2003
1999
1998
1996
1983
1982
1979
1976
1967
1963
1961
1955
1951
1950
1949
1944
1943
1938
1925
1924
1922
1919
1918
1901
1898
1897
1885
1880
1860
1856
1834
1830
1817
1809
1800
1799
1798
1794
1790
20%
1997
1995
1991
1989
1985
1980
1975
1945
1936
1928
1927
1915
1904
1852
1850
1832
30%
1958
1935
1908
1879
1863
40%
1954
1933
1862
1808
1804
50%
1843
1814
60%
70%
80%
Callan Associates  Knowledge for Investors
Source: Ibotson, Roger G., Investment Markets (Updated)
9
2009 Capital Market Projections
12/08
12/06
12/04
12/02
12/00
12/98
12/96
12/94
12/92
12/90
12/88
12/86
12/84
12/82
12/80
12/78
12/76
12/74
12/72
12/70
12/68
12/66
12/64
12/62
12/60
12/58
12/56
-10%
12/54
12/52
12/50
12/48
12/46
12/44
12/42
12/40
12/38
12/36
12/34
12/32
12/30
Rolling Annualized Return (%)
Rolling 5-Year Geometric Returns
Rolling 5 Year Returns for S&P 500 (1926 to 2008)
40%
30%
20%
10%
10.35%
5.78%
0%
-2.19%
Actual
Average
Smoothed
-20%
Callan Associates  Knowledge for Investors
10
Credit Spreads Exceed Historic Highs
Investment Credit Spreads over Treasury Instruments
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
11
Potential Implications of Financial Crisis
 Structure of U.S. financial system is changed permanently.
–
–
–
–
–
End of traditional investment banks.
Consolidation of financial institutions into large, highly regulated commercial banks.
More government oversight and regulation.
Lower leverage and ultimately lower risk in financial system.
Tighter credit conditions for foreseeable future.
 U.S deficit and overall federal debt will expand dramatically.
–
–
–
Trillion dollar plus deficits likely in near term.
Risk of devaluation of U.S. dollar elevated.
Long-term risk of higher real interest rates and crowding out of private borrowing.
 U.S. consumer is being forced to delever.
–
–
–
Loss of wealth in housing and equities will change behavior.
Less spending and consumption.
Postponed retirements, second jobs, will expand labor force.
 Financial markets become smaller and less efficient.
–
–
–
Fewer market makers with smaller balance sheets.
Derivative markets shrink due to increased regulation and tighter risk controls.
Lower leverage from Wall Street firms suggests lower profitability and lower compensation,
pushing human capital away from finance into other areas.
2009 Capital Market Projections
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12
U.S. Economic Growth by Sector
(Annual percent change)
Real GDP
Consumption
Residential Investment
Bus. Fixed Investment
Federal Government
State & Local Govt.
Exports
Imports
2007 Share of
GDP
100%
72%
4%
12%
7%
11%
12%
17%
2002
1.6
2.7
4.8
-9.2
7.0
3.1
-2.3
3.4
2003
2.5
2.8
8.4
1.0
6.8
0.2
1.3
4.1
2004
3.6
3.6
10.0
5.8
4.2
-0.2
9.7
11.3
2005
2.9
3.0
6.3
7.2
1.2
-0.1
7.0
5.9
2006
2.8
3.0
-7.1
7.5
2.3
1.3
9.1
6.0
2007
2.0
2.8
-17.9
4.9
1.6
2.3
8.4
2.2
2008
1.2
0.3
-21.0
1.9
5.7
1.2
6.4
-3.1
Direction of Change
Contracting now
Contracting now
Falling Sharply
Surge halted abruptly
Surging higher
Tax revenue in jeopardy
Reversing course
Oil Prices
 Housing downturn reduced GDP growth by over 1.0% each year in
2007 and 2008 through direct effect on construction alone.
 Note: Imports are a negative number in the calculation of GDP.
Source: Global Insight
2009 Capital Market Projections
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13
Hard Landing for the U.S. Economy
*2009 estimate - Global Insight
(Real GDP - annual percent change)
5
4
3
2
1
0
-1
-2
-3
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
Source: Global Insight
2009 Capital Market Projections
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14
The Current Economic Environment
Worst Recession in the Post-War Era?
 Largest global housing and credit bubble in history has burst.
 Households, businesses and governments face tight (or no access to) credit
and massive wealth destruction.
 The U.S. economy entered recession in December 2007.
–
Better than expected growth in the first half of 2008 was an illusion conjured
by trade and the stimulus package.
 Housing has been in recession for three years, subtracting at least a
percentage point from GDP growth in both 2007 and 2008.
–
Offset by strength in non-residential construction and the closing of the trade
gap – each added back half a point of growth in 2007.
–
Housing market has another bad year in front of it.
 Consumer confidence is deep in recession territory.
–





Job market has turned sour, piling on to the woes from the housing and stock
markets.
Rest of the world is going into severe recession, undermining exports.
Economy is in a free-fall right now – recession may be long and deep.
Lower oil prices offer some cushion.
Fed is doing all it can; major fiscal stimulus is coming.
Sustained upturn may have to wait until the second half of 2009.
2009 Capital Market Projections
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15
The Current Economic Environment
Slow going until 2010.
 Optimistic outlook: government intervention stabilizes credit markets, fiscal
stimulus kick-starts rapid upswing. Beware of inflation lurking in the wings.
 Pessimistic scenario: vicious downward spiral between the economy and
credit markets worsens. Specter of deflation looms.
 Most likely scenario: severest declines in GDP will be recorded in fourth
quarter of 2008 and first quarter of 2009. GDP resumes modest growth in the
second half of 2009, as credit markets slowly unthaw and confidence returns.
 Impact of policy will take time.
–
Monetary policy impact is famously “long and variable”.
–
Substantial fiscal policy has prospects for quicker success, but infrastructure
spending will take years, not months, to show up.
 Policy is not cheap: fiscal 2008 deficit beat the 2004 record; 2009 deficit will
more than double.
 Economy will feel like it is in recession well into 2010, when unemployment
will peak, potentially reaching 10%.
 Equity markets tend to begin recovering before recession ends. Experience
after major bear markets since WWII suggests strong performance in the
subsequent period.
2009 Capital Market Projections
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16
The Current Economic Environment
Slow going until 2010.
 The Fed cut rates 500 basis points in response to the financial turmoil
that began unfolding in 2007.
–
The Federal Funds Rate is now down to 0.25%.
–
The Fed is focused on stabilizing the financial system and kick-starting the
economy. Deflation is a real problem once again; future inflationary pressures of
Fed and Treasury actions are less of a concern.
 Callan’s outlook:
–
Inflation will be contained and low interest rates will persist.
–
Historic nominal return averages may be hard to achieve over the long run, but...
–
Stocks will likely lead the economic recovery, and could generate above-trend
results coming off the bottom. The timing is unclear.
–
Solvency rather than liquidity is the real problem that must be worked through in
the capital markets – liquidity is emotion, solvency is hard numbers.
–
The dollar will likely remain down as the Fed focuses on fighting a recession, but
U.S. Treasuries will continue to be valued as the safest store of value in a time of
uncertainty.
 Biggest challenge facing investors – determining when we might hit
bottom in the slowdown, and how the capital markets will respond.
2009 Capital Market Projections
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17
Equity Is More Reasonably Priced
Trailing P/E Dips Below Its Long Run Average
Price to Earnings Ratio for S&P 500 (1954 - 2008)
45
S&P 500 P/E Ratio
Price/Earnings Ratio
40
Long-Run Average
35
+ 2 Std. Dev.
30
25
20
15
10
- 2 Std. Dev.
5
2004
1999
1994
1989
1984
1979
1974
1969
1964
1959
1954
0
Trailing earnings as reported for the fiscal year; includes negative earnings from 1998 onward.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
18
Past Recessions and Subsequent Market
Performance
 Reproduced from JP Morgan Guide to the Markets, December 31, 2008.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
19
Current Yield is Exceptionally Low
Aggregate Masks Substantial Divergence in Sector Yields
Lehman Aggregate Index - Daily Yield to Worst from 1/1/01 to 1/16/09
6.75%
6.50%
6.25%
12/31/2001
6.00%
03/25/2002
06/28/2006
5.75%
06/12/2007
12/29/2006
10/31/2008
09/10/2001
5.50%
Yield to Maturity
11/04/2005
5.25%
03/28/2005
06/14/2004
5.00%
12/05/2006
11/07/2001
4.75%
09/03/2003
12/30/2005
12/31/2007
4.50%
4.25%
01/23/2008
4.00%
12/31/2004
12/31/2002
3.75%
12/31/2003
3.75%
3.99%
12/31/08
03/16/2004
3.50%
01/08/2009
3.25%
06/13/2003
2009 Capital Market Projections
12/02/2008
09/04/2008
06/10/2008
03/14/2008
12/17/2007
09/19/2007
06/25/2007
03/29/2007
01/02/2007
10/04/2006
07/11/2006
04/13/2006
01/18/2006
10/19/2005
07/25/2005
04/28/2005
02/01/2005
11/03/2004
08/09/2004
05/13/2004
02/18/2004
11/19/2003
08/22/2003
05/29/2003
03/04/2003
12/05/2002
09/09/2002
06/13/2002
03/20/2002
12/20/2001
09/24/2001
06/25/2001
03/29/2001
01/02/2001
3.00%
Callan Associates  Knowledge for Investors
20
2009 Capital Market Projections
Domestic Fixed
Callan Associates  Knowledge for Investors
2008
2007
2006
Price Return
2005
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
Total Return
2004
2003
2002
-15.00
2001
-15.00
2000
-10.00
1999
-10.00
1998
-5.00
1997
-5.00
1996
0.00
1995
0.00
1994
5.00
1993
5.00
1992
15.00
1991
15.00
1990
20.00
1989
20.00
1988
25.00
1987
25.00
1986
30.00
1985
30.00
1984
35.00
1982
-15.00
1983
-10.00
1981
-5.00
1982
0.00
1980
5.00
1981
15.00
1979
15.00
1980
20.00
1978
20.00
1979
25.00
1977
25.00
1978
1976
10.00
Return (%)
30.00
1977
10.00
Return (%)
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
Return (%)
30.00
1976
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
Return (%)
35.00
BC Aggregate Index - Annual Return Breakdown
35.00
Coupon Return
10.00
5.00
0.00
-5.00
-10.00
-15.00
35.00
Other Return
(Paydown)
10.00
Source: www.lehmanlive.com.
21
Does the Treasury Yield Curve Relate to
Broad Market Opportunities?
U.S. Treasury Yield Curves
5.5
5.02
(Source: Federal Reserve Constant Maturity,
3mo/1yr/2yr//5yr/10yr/20yr/30yr)
4.70
5.0
4.81
4.71
4.5
Yield (%)
4.0
4.04
3.36
4.45
3.5
3.45
3.0
2.5
12/31/2004
12/31/2005
12/31/2006
12/31/2007
12/31/2008
2.0
1.5
1.0
0.5
0.0
1
21
11
31
Maturity (Years)
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
22
Bond Market Opportunities
 We don’t know when markets will react positively to the extraordinary
governmental policy actions taken to restore liquidity to credit markets, but we
are confident that they will.
 We believe that risk spreads (both credit and equity) have reached very
attractive levels and patient investors will be handsomely rewarded from recent
price levels.
 We do not expect credit spreads to return to the slim premiums of 2004 to early
2007.
 The extraordinarily low yield and duration on the Aggregate mask the extreme
divergence between the component sectors of the index, and therefore the
potential opportunities.
 Very large increase in specialized “distress” oriented fixed investing.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
23
2009 Capital Market Expectations
 Major question - Did we go through a “game-changing”
experience, or a somewhat extreme but within-the-bounds-ofexpected bump in the long-term capital markets road?
 All asset classes repriced in the recent market dislocation. Value
opportunities are emerging throughout the capital markets.
General theme: this revaluation suggests better potential returns
going forward, and a steeper capital market line.
 We held our inflation expectation at 2.75%. Inflation topped 5%
in mid-2008 yet finished the year with a decline. A recession
solved our inflation problem over the short term, and the
reversal in oil prices played a large role. Inflation could easily
resume, especially given the massive monetary and fiscal
stimulus in the pipeline.
 Cash is projected to generate a slight positive real return (3.0%).
We do not expect current low rates to persist over a five- to tenyear time horizon.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
24
2009 Capital Market Expectations
 Bond returns held at 5.25%. Current measures of the broad market are
very unusual. We expect Treasury rates to rise, but spreads will narrow
and opportunities abound in the non-Treasury portion of the market.
 Project an upward sloping yield curve, with a risk premium for bonds
over cash (2.25%).
 Building equity returns from long-term fundamentals gets us to about
9%: 3-4% real GDP growth, which means 5.75%-6.75% nominal
earnings growth, 2% dividend yield, 0.5%-1.0% “buyback yield”. Shorter
term, these fundamentals may look weak, but equity looks cheap
relative to longer-term valuations. Equity markets tend to perform well
after substantial declines, and typically lead the economy out of
recession. Broad U.S. equity expectations are increased 50 bps, from
9.0% to 9.5%. Non-U.S. equity returns are increased by a similar
amount.
 Real estate return held at 7.6%; returns may not recover as quickly as
liquid equity markets.
 Private equity return held at 12%, narrowing its premium over public
equity markets.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
25
NACUBO Study – Data as of 6/30/08
How are others with similar objectives invested?
Average Asset Class Allocation of Total Assets
Greater Than $1 Billion
> $500 Million to ? $1 Billion
> $100 Million to ? $500 Million
> $50 Million to ? $100 Million
> $25 Million to ? $50 Million
Less Than or Equal to $25 Million
%
39.4
42.5
50.4
54.1
57.6
55.9
Fixed
Income
%
10.8
14.6
16.5
20.3
20.8
27.1
Public
Private
51.7
52.0
21.4
18.1
3.5
4.4
4.8
3.4
11.0
13.8
2.9
3.5
0.8
1.2
2.4
2.2
1.6
1.5
Equal-weighted Average
Dollar-weighted Average
51.9
40.0
19.2
13.1
4.1
6.5
3.9
0.5
12.9
21.0
3.3
8.4
1.1
3.2
2.2
6.5
1.5
0.9
Investment Pool Assets
Equity
Real
Estate
%
6.4
6.1
4.1
4.2
4.1
2.2
%
1.4
1.9
2.5
4.4
3.4
8.1
Hedge
Funds
%
22.6
19.2
16.4
11.5
10.4
3.3
Private
Equity
%
10.0
7.7
4.3
1.8
1.0
0.6
Venture
Capital
%
3.6
2.8
1.2
0.5
0.3
0.3
Natural
Resources
%
5.3
3.5
3.0
.19
1.2
0.4
Cash
Other
%
0.5
1.7
1.7
1.4
1.1
2.1
774 institutions provided investment pool asset class data in 2008. Table data are equal weighted unless otherwise noted. Natural resources include: Timber, Oil
and Gas Partnerships, and Commodities.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
26
2009 Capital Market Expectations
Return and Risk
Asset Class
Broad Domestic Equity
Large Cap
Small/Mid Cap
International Equity
Emerging Markets Equity
Global
Domestic Fixed
Non US Fixed
Real Estate/Infrastructure
Private Equity
Absolute Return
Cash Equivalents
5-Year
10-Year
Arithmetic Geometric Geometric Projected
Mean
Mean
Mean
S.D.
10.35
9.63
9.49
16.39
9.95
9.36
9.23
15.25
11.95
10.33
10.05
22.60
10.60
9.47
9.26
19.30
13.00
10.54
10.13
27.00
10.28
9.63
9.49
15.85
5.25
5.25
5.24
5.00
5.15
4.88
4.83
9.60
8.55
7.75
7.61
16.10
17.25
12.38
11.59
37.00
7.20
6.99
6.93
10.00
3.00
3.03
3.03
0.80
Source: Callan Associates Inc.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
27
2009 Capital Market Expectations
Correlation Coefficient Matrix
Key to Constructing Efficient Portfolios
Broad
Domestic
Equity
Broad Domestic Equity
1.00
Large Cap
0.98
Small/Mid Cap
0.94
International Equity
0.68
Emerging Markets Equity
0.79
Global
0.89
Domestic Fixed
0.15
Non US Fixed
-0.04
Real Estate/Infrastructure
0.54
Private Equity
0.92
Absolute Return
0.56
Cash Equivalents
-0.12
Large
Cap
0.98
1.00
0.90
0.68
0.79
0.89
0.17
-0.02
0.54
0.91
0.56
-0.10
Small/
Mid Cap
0.94
0.90
1.00
0.64
0.74
0.82
0.07
-0.06
0.51
0.87
0.51
-0.15
Interna- Emerging
tional Markets
Domestic Non US
Equity
Equity
Global
Fixed
Fixed
0.68
0.79
0.89
0.15
-0.04
0.68
0.79
0.89
0.17
-0.02
0.64
0.74
0.82
0.07
-0.06
1.00
0.75
0.94
0.14
0.18
0.75
1.00
0.84
0.05
0.05
0.94
0.84
1.00
0.17
0.10
0.14
0.05
0.17
1.00
0.43
0.18
0.05
0.10
0.43
1.00
0.51
0.53
0.57
0.15
0.05
0.85
0.85
0.96
-0.02
0.02
0.60
0.53
0.63
0.41
0.24
-0.20
-0.15
-0.17
0.30
0.10
Real
Estate/
Infra
0.54
0.54
0.51
0.51
0.53
0.57
0.15
0.05
1.00
0.55
0.43
-0.06
Private Absolute
Equity
Return
0.92
0.56
0.91
0.56
0.87
0.51
0.85
0.60
0.85
0.53
0.96
0.63
-0.02
0.41
0.02
0.24
0.55
0.43
1.00
0.54
0.54
1.00
-0.10
0.15
Cash
Equivalents
-0.12
-0.10
-0.15
-0.20
-0.15
-0.17
0.30
0.10
-0.06
-0.10
0.15
1.00
Source: Callan Associates Inc.
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
28
Illustrative Efficient Mixes Using 2009 Projections
Portfolio
Component
Large Cap
Small/Mid Cap
International Equity
Global
Emerging Markets Equity
Domestic Fixed
Non US Fixed
Real Estate/Infrastructure
Private Equity
Absolute Return
Cash Equivalents
Totals
Target
21
5
8
14
5
19
3
13
6
6
0
100
Expected Return
5 Yr. Avg. Simulated Return
10 Yr. Avg. Simulated Return
Standard Deviation
9.35
9.00
8.91
12.82
2009 Capital Market Projections
Min
0
0
0
0
0
0
0
0
0
0
0
Max
100
100
100
100
100
100
100
100
100
100
100
Mix 1
15
4
3
6
1
56
4
6
2
3
0
100
Mix 2
17
5
4
8
2
47
3
7
3
4
0
100
Mix 3
20
6
5
10
3
38
2
7
4
5
0
100
Mix 4
23
7
6
12
3
28
1
8
6
6
0
100
Mix 5
26
8
7
14
4
18
0
9
7
7
0
100
Mix 6
29
9
9
17
4
5
0
10
8
9
0
100
7.27
7.25
7.22
7.30
7.83
7.75
7.71
8.65
8.41
8.25
8.19
10.17
9.02
8.75
8.67
11.85
9.68
9.25
9.15
13.72
10.38
9.75
9.62
15.75
Callan Associates  Knowledge for Investors
29
Efficient Frontier Graph
10.0
Mix 6
5-Year Geometric Mean Return (%)
9.5
Target Mix
Mix 5
9.0
Mix 4
8.5
Mix 3
8.0
Mix 2
7.5
Mix 1
7.0
7
8
9
10
11
12
13
14
15
16
17
Risk (Standard Deviation)
2009 Capital Market Projections
Callan Associates  Knowledge for Investors
30
Supplemental Material
2009 Capital Market Projections
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Housing Information
2009 Capital Market Projections
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Home Prices
2009 Capital Market Projections
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Consumer Balance Sheet
2009 Capital Market Projections
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Unemployment & Employment Trends
2009 Capital Market Projections
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Consumer Sentiment
2009 Capital Market Projections
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Oil Prices & Impact
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S&P 500 2008
2009 Capital Market Projections
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Performance during recessions
2009 Capital Market Projections
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Ted Spread – Huge Improvement From Sept – Nov.
2009 Capital Market Projections
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Long-term High Yield Default Experience
Graph reproduced from Principal Global Investors Jan. 2009
2009 Capital Market Projections
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Tax Exempt Yields vs. Treasury
2009 Capital Market Projections
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Market Background
2009 Capital Market Projections
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Projections from others - GMO
GMO 7-Year Asset Class Return Forecasts*
- Expected Value Added
- Real Return (Asset Class Index)
As of December 31, 2008
Stocks
Bonds
Other
16%
6.5 % Long-term
Historical U.S.
Equity Return
14%
1.8%
Annual Real Return Over 7 Years
12%
10%
8%
13.8%
13.0%
13.6%
2.3%
11.1%
3.7%
2.3%
8.9%
8.6%
1.8%
1.8%
7.5%
6.8%
1.5%
6%
11.5%
11.2%
2.9%
9.9%
8.8%
4%
7.1%
2.9%
6.8%
2%
3.9%
0.4%
0.9%4
-0.5%
0%
0.9% 4
2.0%
-0.2%
6.0%
1.6%
2
1.4%
0.2%
-1.1%
0.9%
-2%
U.S.
U.S.
U.S. High
Int'l.
Int'l.
Equities U.S. Bonds Int'l. Bonds
Bonds
equities
equities
Quality
equities
equities (emerging)
(gov't.)
(gov't.)
(emerging)
(large cap) (small cap)
(large cap)3 (small cap)3
Estimated Range of
7-Year Annualized Returns
±6.5
±7.0
±6.0
±6.5
±7.0
±10.5
±4.0
±4.0
±8.5
Bonds
(inflation
indexed)
±1.5
U.S.
Managed
treasury
Timber
(30 days to
2 yrs.)
±1.5
±5.5
forecasts 1
*The chart represents real return
for several asset classes and an estimate of value expected to be added from active management. These forecasts are forwardlooking statements based upon the reasonable beliefs of GMO and are not a guarantee of future performance. Actual results may differ materially from the forecasts above.
1
2
Long-term inflation assumption: 2.5% per year.
Alpha transported from management of global equities.
2009 Capital Market Projections
3
4
Return forecasts for international equities are ex-Japan.
Alpha transported from management of global bonds.
Source: GMO
Callan Associates  Knowledge for Investors
44
JP Morgan Asset Class Projections
Source JP Morgan 11/30/08
2009 Capital Market Projections
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Year-end Strategists Projections
2009 Capital Market Projections
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