HOUSE_OVERSIGHT_025219.jpg

Recent bank stress tests conducted by the EU concluded that only Eur 2.5 billion of capital needs to be raised (70 to 80
billion sounds more reasonable to us). And in the package announced last week, the following Orwellian clause
indicates how European policymakers feel about rating agencies these days:

Point 15. We agree that reliance on external credit ratings in the EU regulatory framework should be
reduced, taking into account the Commission's recent proposals in that direction, and we look forward to the
Commission proposals on credit ratings agencies

In Europe, denial appears to be an essential ingredient to the process (See "Five Stages of Greece", June 30, 2011). Last
week’s package is a bold step towards Federalization and the worst-case outcomes have been avoided (money
market failures, bank runs, etc), but markets will remain nervous about Europe.

While we’re waiting: large cap growth stocks
One day, the melodramas around US and European sovereign debt will end. While we’re waiting, one of the asset classes
that looks attractive is large cap growth stocks. As shown below (for a universe of 300 U.S. large cap growth stocks that
meet certain earnings quality and stability factors), free cash flow relative to both revenues and stock prices looks
good compared to the last four decades. This is where we believe investors should be adding exposure if they are
underweight versus their desired equity allocations. This is also an asset class where active management can still provide
a lot of value; the dispersion of large cap growth managers is higher than large cap core, large cap value and international
equity manager dispersion.

Attractive valuations for US large cap growth stocks
Percent
9%
8%
Nominal free cash yield
7%
6%
5%
4%
3%
2%
1%
0%
-1%
Post-dividend free cash flow margin
-2%
'71 '74 '77 '80 '83 '86 '89 '92 '95 '98 '01 '04 '07 '10
Source: Empirical Research Partners.

Q2 earnings season in the US is off to a good start. Nearly 30% of the S&P has reported, and results have generally
been positive. Earnings are beating consensus estimates by almost 4% (7.4% ex-financials), all ten sectors are beating on
revenue targets, and only 7% of companies are reporting below-consensus earnings. Given earnings expectations for
2011 at $98.50, the S&P 500 is trading at a reasonable 13.5x forward multiple. However, y/y earnings growth
expectations appear to be flattening out for both 2011 and 2012 at around 11%-12%. While Q2 earnings are doing well
so far, some company guidance for the remainder of the year has been below consensus, which would be consistent with
the recent batch of reports indicating a slowdown in manufacturing and service sector surveys.

Michael Cembalest
Chief Investment Officer

Notes
[a] Bundesbank President Weidmann, in response to last week’s package: “By transferring significant risks to the
support-giving countries and their taxpayers, the Euro area has taken a large step to socialising risks created by unsound
government finances and macroeconomic problems. This weakens the foundations of the fiscal self-responsibility that
EMU is built on”.

CBO Congressional Budget Office
OMB Office of Management and Budget
EFSF European Financial Stability Facility
FICA Federal Insurance Contributions Act
EU European Union
IMF International Monetary Fund

HOUSE_OVERSIGHT_025219