Investment Strategies Group Banc of America Investment Advisors

Capital Market Outlook Week of March 16, 2009

Joseph P. Quinlan, Managing Director & Chief Market Strategist

Harvey B. Hirschhorn, CFA, Managing Director & Chief Portfolio Strategist

HIGHLIGHTS
• Treasuries have become the U.S. assets of choice for foreigners during the current crisis.
• U.S. dependence on foreign capital continues to intensify as the government ramps up borrowing.
• Falling markets have changed the sector weightings of benchmark indexes.

ECONOMIC OUTLOOK
Joseph P. Quinlan
FOREIGN OWNERSHIP OF U.S. ASSETS — A SNAPSHOT Treasuries, government agency bonds, corporate bonds
Chinese Premier Wen Jiabao recently claimed that he and equities — remains at or near record highs.
was “worried” about his nation’s roughly $1 trillion in However, during the past few quarters, foreign
U.S. debt holdings. As one of the largest investors in investors have become less enamored with U.S.
U.S. Treasuries, he has every right to be concerned — government agency bonds and U.S. equities, a position
although airing these concerns in public is quite rare. that is hardly surprising, given the turmoil in the U.S.
Indeed, rare is the day that any world leader raises financial markets
questions about the safety of U.S. Treasuries, during the past year
Foreign ownership of
considered to be among the world’s safest investments. or so. U.S. financial assets —
Treasuries, government
Against this backdrop, we thought it would be a good Exhibit 1 on the next agency bonds, corporate
time to refresh and review the magnitude of foreign page highlights some
investment in U.S. securities.
bonds and equities —
of the latest flow of
funds data from the
remains at or near
Based on the latest Federal Reserve Flow Fund data,
Federal Reserve. record highs.
foreign ownership of U.S. financial assets —

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 Exhibit 1 — U.S. assets in demand overseas
(Foreign ownership of U.S. securities,
share of total ownership, percent)
Fourth quarter 2000 Fourth quarter 2008
60
50
50.3
40
30.4
28.8
30
19.8
20 16.2
10 8.0
0
U.S. Treasuries U.S. agency & GSE U.S. corporate
bonds bonds
Sources: Federal Reserve Board; Investment Strategies Group
Data through Dec. 31, 2008
We drew several key insights from this data:
U.S. Treasuries — Foreign ownership of U.S.
Treasuries increased dramatically in the past decade
and has never been higher. Foreign investors owned
50.3% of outstanding U.S. Treasuries at the end of
2008, up from a share of 47.7% in the final quarter of
2007. The share of U.S. Treasuries held by foreigners
has more than doubled since the mid-1990s. China and
Japan are today’s largest foreign holders.
U.S. government agency bonds — Given all the financial
turmoil surrounding U.S. government agency bonds,
there is little wonder that foreign appetite for them has
diminished during the past few quarters. After steadily
rising for most of this decade, the share of foreign
ownership of U.S. government agency bonds slipped to
16.2% in the fourth quarter of last year, down from a
peak of 21.2% the prior year. At the end of 2008,
foreigner investors owned some $1.3 trillion in
government agency bonds, down from $1.6 trillion in the
fourth quarter of 2007.
U.S. corporate bonds — Foreign investors have never
been as important to the U.S. corporate bond market as
they are today. They owned roughly 29% of total
outstanding U.S. corporate bonds in the fourth quarter
of last year, up from a share of 25.6% in 2000. Foreign
ownership of U.S. corporate bonds rose by a modest
1.2% between the fourth quarter of 2007 and the fourth
quarter of 2008.
U.S. equities — Overseas investors’ holdings in U.S.
stocks declined sharply, from $2.7 trillion from the
fourth quarter of 2007 to $1.8 billion in the fourth
quarter of 2008. The nearly 35% decline was
precipitated, of course, by the U.S. global credit crisis of
late 2008. The share of outstanding U.S. equities owned
by foreign investors remains at or near record highs. In
the fourth quarter of 2008, foreigners owned roughly
14.5 15% of total outstanding U.S. equities, up from a 9.4%
9.4 share at the start of the decade.
U.S. equities
MARKET COMMENTARY
Joseph P. Quinlan
FOREIGN OWNERSHIP OF U.S. ASSETS — TREASURIES TRUMP ALL
With the United States already one of the largest
debtor nations and Washington burrowing deeper into
debt, the foreign appetite for U.S. financial assets —
Treasuries, government agency bonds, corporate bonds
and equities — has never been as important as it is
today. America’s soaring dependence on foreign capital
remains one of the weakest links in the U.S. economy.
For years, the United States has spent more than it
saved annually — drawing from overseas supplies of
excess capital. This decade, U.S. net capital inflows
have averaged nearly $700 billion annually, versus an
annual average of just $139 billion during the 1990s.
This capital injection helped U.S. consumers purchase
new cars and homes, U.S. businesses finance new
investments, and the U.S. government enjoy both guns
and butter — large military outlays and tax cuts.
Foreign capital has been a key staple of U.S. economic
expansion this decade.
Looking ahead, the role of foreign capital inflows is
likely to become even more important as the United
States digs deeper into debt to offset one of the worst
recessions since the 1930s. Make no mistake about it —
the U.S. government will have to underpin and
underwrite a substantial share of its mega-borrowing
with foreign capital.
2
Against this backdrop, the latest numbers from the time in 2010 — right now, we are more concerned about
Federal Reserve’s Flow Fund data are quite interesting. deflation than inflation.
During the global flight to quality in the final quarter of
THE BOTTOM LINE
2008, U.S. Treasuries emerged as the favorite
We are worried about the swelling U.S. federal budget
destination for foreign investors searching for relatively
deficit, which is expected to top 12% of GDP in fiscal
safe havens. Other assets were disposed of rather
2009, and its subsequent impact on U.S. capital inflows.
quickly. During the flight from risk triggered by the
The massive fiscal stimulus represents a bold gamble,
U.S.-led financial crisis, which reached a climax in
one that will surely test the patience and nerves of
September 2008, foreign investors bailed out or greatly
foreign investors.
reduced their purchases of U.S. government agency
bonds, corporate bonds and equities.

While overseas investors shed other U.S. assets,

foreign demand for U.S. Treasuries surged. Foreign
ownership of Treasuries climbed to $3.2 trillion in the INVESTMENT STRATEGY 1

final quarter of last year — up from $2.9 trillion at the Orhan Imer, PhD., senior quantitative research analyst
end of the third quarter of 2008 and a rise of one-third Harvey B. Hirschhorn, CFA
from the same period a year earlier. U.S. EQUITIES

THE LESSONS OF THE WORLD’S LOVE FOR TREASURIES After weeks of continual selling pressure, the stock
In times of global crisis and panic, U.S. Treasuries market finally showed some life. Last week’s rally
remain one of the most desired asset classes among started with constructive comments from Citigroup
investors around the world. When financial turmoil sets regarding its corporate performance in early 2009.
in, many foreign investors have more faith in Uncle Retail sales news boosted the further upward trajectory.
Sam than leading financial institutions or their own Sales slipped modestly, but higher transfer payments
governments. That is the good news. and strong tax refunds (compared to a year ago) kept
them above expected levels.
The more discouraging news is this — the U.S.
government’s era of big spending and big borrowing Comments from Washington regarding the uptick rule
has foreign investors concerned, and for good reason. and mark-to-market accounting also brought new
Their overriding fear, explicitly expressed by China last money into the stock market, supporting prices. Both
week, is that the deeper the U.S. government goes into regulations may have influenced the breadth, depth and
debt, the greater the risk of inflation and the greater speed of the bear market. Congress may modify or
the odds of a collapse of the U.S. dollar at some point adjust these regulations, which apparently pushed
down the road. If the dollar collapsed, foreign investors short-sellers to cover some of their negative bets.
would be left holding an empty or heavily devalued bag
For the week, the Dow Jones Industrial Average
of Treasuries.
rose 9.0%, the S&P 500 gained 10.1%, and Nasdaq
Clients often ask us whether a dollar collapse is jumped 10.6%.
imminent or inevitable. Our answer is “no,” as long as BENCHMARK SECTOR WEIGHTS
the U.S. government avoids the path of protectionism, U.S. equities have slogged through a protracted bear
the U.S. economy emerges from recession ahead of market since the S&P 500 Index hit a record high of
others by the end of the year, U.S. companies remain 1,565.15 on Oct. 9, 2007. While the majority of stocks
among the most competitive and attractive in the world, have suffered significant losses since that peak, the
and the U.S. Federal Reserve maintains its anti- downturn has affected economic sectors differently. By
inflation credentials. The Fed will be put to a test some studying how equity benchmarks changed the
1
All sector and asset allocation recommendations must be considered in the context of an individual investor’s goals, time horizon and risk
tolerance. Not all recommendations will be suitable for all investors. Equity securities are subject to stock market fluctuations that occur in
response to economic and business developments. Investing in growth stocks incurs the possibility of losses because their prices are
sensitive to changes in current or expected earnings. Value stocks are securities of companies that may have experienced adverse business
or industry developments or may be subject to special risks that have caused the stocks to be out of favor. If the manager’s assessment of
a company’s prospects is wrong, the price of its stock may not approach the value the manager has placed on it. Stocks of small- and mid-
cap companies pose special risks, including possible illiquidity and greater price volatility than stocks of larger, more established companies.
3
proportion in which they represent sectors, we can shed
some light on how stocks from different segments of the
economy fared during this period.
Exhibits 2 and 3 on the next page show the sector
compositions of the large-cap Russell 1000 Index and
the small-cap Russell 2000 Index, respectively. The first
two columns of each table show the weighting within
each benchmark of the 10 Global Industry Classification
Standard (GICS) economic sectors in October 2007 and
February 2009. Weightings reflect the market
capitalization of each sector as a share of total index
market capitalization and are the average of all daily
weightings in the given month.
The following insights are drawn from how the Russell
1000 Index composition changed, as seen in Exhibit 2:
• During the stock market peak of October 2007,
financial companies made up the largest component
of the Russell 1000 Index, at close to 20% of the
benchmark’s total market capitalization. The
Financials sector was also the hardest hit during the
downturn, seeing its weight cut from 19.3% in October
2007 to 10.8% in February 2009 — almost in half.
• Consumer Discretionary companies, dependant on a
healthy and expanding economy, also took a hit. The
sector’s share of the benchmark declined from 10.2%
in October 2007 to 8.8% in February 2009.
• While the Financials and Consumer Discretionary
sectors fell out of favor, the Consumer Staples sector,
which tends to be less sensitive to economic cycles,
increased its share of the benchmark. The sector’s
weight peaked at 12.5% in November 2008, but has
since declined slightly, to 12.0%. It remains well above
the October 2007 level of 8.8%.
• As of February 2009, the Energy and Materials
sectors made up a larger percentage of the
benchmark than in October 2007. However, their
more recent weights are still well below July 2008
levels — when energy and commodity prices peaked.
• The Health Care, Utilities and Information
Technology sector weights in the benchmark have
increased. Companies in these sectors are perceived
as relative safe havens with less economically
sensitive cash flows.
2
The 10-year Treasury note is used solely as a benchmark for long-term interest rates.
• The Industrials sector’s benchmark weight declined
from 11.8% in October 2007 to 10.4% in February
2009, while the Telecommunication Services sector
remained relatively stable, with an unchanged weight
of 3.6%.
As Exhibit 3 highlights, GICS sector weights within the
small-cap Russell 2000 Index followed similar trends to
their large-cap counterparts, with the exception of the
Energy, Financials, Industrials and Information
Technology sectors:
• Unlike large-cap Financials, small-cap Financials still
accounted for more than 20% of the small-cap
benchmark’s market capitalization as of February
2009, slightly up from 19.8% in October 2007.
• While the share of large-cap Energy companies
increased, small-cap energy companies now make up
only 4.5% of the small-cap benchmark, down from
6.4% in October 2007.
• Information Technology companies increased their
weight in the large-cap benchmark but withdrew in
small caps — their benchmark weight decreased from
18.6% in October 2007 to 17.0% in February 2009.
• The share of the Industrials in the small-cap
benchmark slightly increased, from 15.2% in October
2007 to 16.2% in February 2009 — in contrast to a
decreasing weight in the large-cap index.
As the above analysis shows, the sector compositions of
equity benchmarks are
not static and may We expect benchmark
fluctuate, sometimes sector weights to
significantly, over time. continue evolving as the
We expect benchmark economic recovery
sector weights to slowly takes shape
continue evolving as the
during the balance of
economic recovery slowly
takes shape during the
the year.
balance of the year.
BOND MARKET
The Treasury market fell under selling pressure as the
stock market bounced higher, a slowing trade into
relative safety and liquidity affected Treasuries and
economic data marginally improved. For the week, the
yield on the benchmark 10-year Treasury note2 firmed
4
Exhibit 2 — Large-cap benchmark sector weightings
(Russell 1000 Index)

* May not add up

to 100% due to
rounding.
Sources:
Bloomberg;
Investment
Strategies Group
Data through Feb.
28, 2009
Refer to index
definitions at the
end of this report.

Exhibit 3 — Small-cap benchmark sector weightings

(Russell 2000 Index)

* May not add up

to 100% due to
rounding.
Sources:
Bloomberg;
Investment
Strategies Group
Data through Feb.
28, 2009
Refer to index
definitions at the
end of this report.

from 2.83% to 2.89%. Although investment grade bonds The Nasdaq Composite Index is a market capitalization price-only
index that tracks the performance of domestic common stocks traded
slipped modestly in price, high-yield3 bonds firmed with on the regular Nasdaq market as well as National Market System-
the stock market. traded foreign common stocks and American Depository Receipts.

The Russell 1000 Index is a capitalization-weighted index that

INDEX DEFINITIONS
The Dow Jones Industrial Average Index, the most widely used
indicator of the overall condition of the stock market, is a price-
weighted average of 30 actively traded blue-chip stocks as selected
by the editors of The Wall Street Journal.
The Standard & Poor's (S&P) 500 Index tracks the performance of
500 widely held, large capitalization U.S. stocks.
measures the performance of the 1,000 largest market-capitalization
companies in the U.S. equity market. The index represents
approximately 92% of the U.S. equity market.
The Russell 2000 Index is a capitalization-weighted index that
measures the performance of 2,000 companies in the U.S. equity
market with small market capitalizations. The index represents
approximately 8% of the U.S. equity market.
Indexes are unmanaged, and an investor cannot invest directly in an
index.

3
Investments in high-yield bonds (sometimes referred to as “junk bonds”) offer the potential for high current income and attractive total
return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a junk bond issuer’s ability to
make principal and interest payments.
5
 Tactical asset allocation (Weightings relative to strategic allocation targets)
Underweight Neutral Overweight Underweight Neutral Overweight
Equities 9 Fixed income 9
Growth 9 Investment grade 9
Value 9 Non-investment grade 9
Large cap 9 Cash 9
Mid cap 9
Small cap 9
Developed international 9

All asset classes are not suitable for all investors. Each investor should select asset classes for investment based on his or her own goals,
time horizon and risk tolerance.

U.S. equity indexes (Price return, percent change) International markets (Percent change)
Close Last Year- Last Equity indexes Close Last Year- Last
3/13/09 week to-date 12 Months (Price return) 3/13/09 week to-date 12 Months

Dow Jones Indstrl Avg. 7,223.98 9.01 -17.69 -40.52 MSCI EAFE 980.53 5.90 -20.76 -51.36

S&P 500 756.55 10.71 -16.24 -42.49 MSCI Europe 864.75 7.69 -21.30 -54.57

S&P 400 MidCap 456.71 11.90 -15.15 -41.11 MSCI Pacific 1,329.36 2.70 -19.74 -43.92

S&P 600 SmallCap 207.17 11.59 -22.91 -42.69 S&P/IFCI Emerging 359.28 7.97 -6.61 -52.18

Currency
Nasdaq Composite 1,431.50 10.64 -9.23 -36.76
Yen per dollar 97.95 -0.31 8.06 -2.68
Russell 1000 Growth 336.03 8.92 -9.47 -38.44
Dollars per euro 1.2928 2.17 -7.47 -17.31
Russell 1000 Value 380.22 12.94 -21.93 -47.02

Russell Midcap Growth 227.67 11.09 -8.75 -43.42

Russell Midcap Value 511.46 12.45 -21.23 -48.04

Russell 2000 Growth 216.13 11.00 -15.93 -40.27

U.S. government bonds (Generic, percent change)
Yield Last Year- Last
Russell 2000 Value 543.29 12.99 -26.12 -44.26 3/13/09 Week to-date 12 months

90-day T-bill 0.20 -0.01 0.09 -1.15

Two-year Treasury 0.98 0.07 0.22 -0.65

Five-year Treasury 1.87 0.04 0.32 -0.66

10-year Treasury 2.89 0.06 0.64 -0.67

10-year TIPS (real) 1.84 -0.18 -0.25 0.84

Sources: Bloomberg; Investment Strategies Group

Indexes are unmanaged, and an investor cannot invest directly
in an index.

6
 U.S. equity sectors (Price return, percent change) U.S. equity industries (Price return, percent change)
10 economic sectors Index Last Year- Last 10 best and worst performing groups Last Year- Last
of the S&P 500 Index weight week to-date 12 months of the S&P 500 Index (of 123) week to-date 12 months
h
Financials 10.37 33.85 -35.18 -67.05 Commercial Banks 50.72 -48.95 -66.53

Industrials 9.61 12.39 -27.56 -54.41 Diversified Financial Services 47.26 -40.78 -70.31

Consumer Discretionary 8.42 12.08 -15.78 -40.72 Automobiles 36.39 -17.42 -72.15

Materials 3.21 11.79 -10.62 -52.05 Consumer Finance 31.94 -41.15 -70.40

S &P 500 100.00 10.71 -16.24 -42.49 Capital Markets 30.74 -3.06 -56.51

Information Technology 17.69 9.77 -3.07 -35.55 Building Products 30.52 -54.27 -72.01

Health Care 15.94 9.51 -9.55 -22.79 Paper & Forest Products 30.03 -30.45 -70.32

Telecommunications 4.01 7.35 -12.12 -27.25 Industrial Conglomerates 28.34 -35.40 -67.62

Energy 13.54 6.70 -14.56 -42.22 Construction & Engineering 24.62 -13.26 -44.64

Consumer Staples 13.13 4.57 -13.75 -25.18 REITs 21.43 -33.16 -61.52

Utilities 4.09 2.17 -19.40 -38.22 S&P 500 10.71 -16.24 -42.49
Internet Software & Services 5.84 3.96 -37.15
Health Care Technology 5.62 -18.14 -42.59
Bond indexes (Barclays Capital, total return, percent change) Food & Staples Retailing 4.42 -11.21 -20.35
Yield to
Last Year- Last Food Products 4.39 -11.49 -23.57
maturity
week to-date 12 months
3/13/09 Beverages 4.29 -11.44 -23.58

Corporate & government 4.09 -0.50 -2.50 1.15 Diversified Consumer Services 3.71 -13.54 9.69

Broad corporate 8.02 -1.08 -3.18 -7.29 Multi-Utilities 3.37 -15.35 -28.59

Non-investment grade 19.59 1.99 1.26 -21.86 Household Products 3.10 -21.47 -28.78

Treasury bills 3.97 0.02 1.41 7.24 Life Sciences 1.55 2.80 -31.44
Electric Utilities 0.26 -21.80 -38.44
Treasury notes & bonds 2.03 -0.25 -2.69 6.57

Agencies 2.47 -0.26 -0.90 5.89

Mortgages 4.26 0.32 1.48 8.55

Municipals 4.24 -0.26 3.38 1.62

Global gov’t., ex-U.S. 2.32 0.63 -7.44 -7.49

Source: Bloomberg
Indexes are unmanaged, and an investor cannot invest directly in an index.

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