Q1 2012Putnam Perspectives

Capital Markets Outlook

Jefrey L. Knight, CFA
HeadofGlobalAssetAllocation
Key takeaways

In 2011, safe assets led while crisis-sensitive

assets crashed. In 2012, opportunity lies in the
middle of these extremes.

The U.S. economy could surprise with better

performance.

Asset allocation choices in 2012 should focus

on geography.
Putnams outlook
Asset class Underweight Small underweight Neutral Small overweight Overweight
EQUITY l
U.S. large cap l
U.S. small cap l
U.S. value l
U.S. growth l
Europe l
Japan l
Emerging markets l
FIXED INCOME l
U.S. government l
U.S. tax exempt l
U.S. investment-grade corporates l
U.S. mortgage-backed l
U.S. foating-rate bank loans l
U.S. high yield l
Non-U.S. developed country l
Emerging markets l
COMMODITIES l
CASH l
CURRENCY
Dollar/yen Neutral
Dollar/euro Favor dollar
Dollar/pound Favor dollar
2
Q1 2012|Capital Markets Outlook
Investment themes
In 2011, safe assets led while crisis-sensitive
assets crashed. In 2012, opportunity lies in the
middle of these extremes.
ForU.S.investors,2011delivereddeceptivelybenignhead-
linereturns.TheS&P500Index,forexample,delivered
2.1%.TheBarclaysCapitalU.S.AggregateBondIndex,
astandardmeasureofinvestment-gradebondperfor-
mance,returnedasolid7.8%.Commodities,asmeasured
bytheGoldmanSachsCommodityIndex,fnishedtheyear
withanunremarkable-1.2%loss.Clearly,tojudgebyindex
returns,2011neithershoweredinvestorswithrichesnor
infictedsignifcantdamage.
Tomanyinvestors,though,2011wasanythingbutbenign.
Forthosewhoventuredawayfromtheseiconicbenchmarks,
theyearfeltmorelikeanIndianaJonesadventure,satisfying
tosurvivebutfraughtwithdramaticperilforanycareless
step.Intruth,therewereveryfewinvestmentopportuni-
tiesthatpaidofwithimpressivegains.Ontheotherhand,
thereweremany,manywaystolosebigin2011,fromGreek
sovereignbonds(-59.6%)toU.S.fnancialstocks(-18.4%)
tocopper(-21.5%)(Source:Bloomberg).
Investorswereunderstandablyjitterylastyear.Three
signifcantrisksposedgenuinefundamentaldownsideto
theintrinsicvalueoftheirinvestments:sovereigndefault
inEurope,adouble-diprecessionintheUnitedStates,
andasignifcantslowdowninChineseeconomicgrowth.
Inresponsetotheserisks,Europeanstocksandbondsof
peripheralmarketsweremarkeddownsharply,defensive
stocksintheUnitedStates(thehealth-care,consumer
staples,andutilitiessectors)outperformeddramatically,
andstocksacrosspartsofAsiafellby20%ormore.Adding
insulttoinjury,though,wasthefactthatnoneoftheserisk
scenariosactuallytranspired!
Ofcourse,wemustacknowledgethatthesescenariosto
somedegreeremainrelevantin2012,andthatdownsiderisk
stillexistsforthesecrisis-sensitiveinvestments.InEurope,
forexample,itislikelythatGreece,ataminimum,willefec-
tivelydefaultduring2012.Lesslikely,inourview,isaU.S.
recessionin2012,orahardlandingforChinaseconomy.We
are,then,intriguedbysomeoflastyearslosersassources
forpotentialrewardin2012,albeitwithelevatedrisks.
Perhapsthemostinterestingopportunities,though,lie
betweentheultrasafeassetsthatoutperformedin2011
andthecrisis-sensitiveinvestmentsthatfellsosharply.
Twoideasstandoutinthisregard.Thefrstishigh-yield
bonds,whichdeliveredpositivereturnsin2011,butonly
becausethepositivecarryofsetpricedeclinesacrossthe
category.Indeed,evenascreditfundamentalsimproved
bymanymeasuresin2011,high-yieldspreadswidened.
As2012begins,thesespreadsareabove7%,asignifcant
premiumoverTreasuriesthatyieldabout2%.
WealsoseeopportunityinU.S.large-capstocks.For
reasonswedetailbelow,wethinkthattheoverallU.S.
economycouldsurpriseontheupsidein2012,andU.S.
stocksarelikelytoappearveryattractiveinaglobal
context.WithintheoveralluniverseofU.S.stocks,tech-
nologystocks,forexample,deliveredverymildreturns
in2011despiteverystrongcorporatefundamentals.The
technologysectorhascontinuedtogrowrevenueand
standsoutinbothitsabilitytogeneratecashfowaswell
asitsfnancialfexibility,thankstobalancesheetstrength.
The U.S. economy could surprise with better
performance
Everyweek,weupdateourindexofeconomicsurprise.
Essentially,wecomparedatareleaseswithexpectations
foundthroughsurveystogaugewhether,acrossabroad
samplingofdatareleases,thefactualeconomictrajectory
isbetterorworsethaneconomistsexpected.Interestingly,
inthecontextofthenegativemarkettoneofthesecond
halfof2011,theU.S.economybeganaconsistentpattern
ofpositivesurprisesaroundJuly.Professionaleconomists
spentmuchofthelatterhalfoflastyearforecastinga
recessionthatnevercame.Wethinktheresilienceofthe
U.S.economyisimportant,andthatthepatternofupside
surprisecouldcontinuein2012.
Even as credit fundamentals
improved by many measures in
2011, high-yield spreads widened.
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3
Unmistakably,theU.S.economyhasbeenfacingahead-
windintheformofdeleveragingforseveralyears.We
mustremember,though,thatthisdeleveragingdoesnot
afectallsectorsoftheeconomy.Indeed,itispossibleto
disaggregatetheoveralleconomyintothosesectorsthat
arefacedwithdeleveragingandthosethatarenot.Gener-
ally,thedeleveragingindustriesarerealestate,fnancials,
andmorerecently,industriesinfuencedbygovernment
spendingorregulation.
Therestoftheeconomyispredominantlyunencumbered
bytheforcesofdeleveraging.Importantly,ifwetrackthe
growthrateofthesenon-deleveragingsectors,theyhave
beenexpandingatabriskpace.Theyhaveevenbeen
addingjobsonaconsistentandsignifcantbasis.Whats
more,anequallyweightedportfolioofstocksfromnon-
deleveragingsectorsmadenearthemarketpeakof2007
wouldhavedeliveredpositivereturnsthroughtheendof
2011(Figure1).Weseenoreasonwhythesetrendsshould
reversein2012.
ThemajorriskstotheU.S.economy,then,resideinthe
deleveragingsectors.Whilethenewsisnotgreatforthese
sectors,thereissomereasontosuggestthat,atworst,the
headwindsareeasing.Inthecaseofrealestate,webelieve
thathomepricesareapproachingbottom.Forthefrst
timeinyears,buyingahomeislessexpensivethanrenting
one.Withmortgagerateshittingrecordlows,home
afordabilityhasreturnedtotraditionallevels.Whileevery
regionhasuniqueconditions,webelieveatanationallevel
itisimportantthattheratioofthemeanhomepricetothe
meanincomehasreturnedtopre-housing-bubblelevels.
Homepricesarelikelytofallfarther,butthecombination
ofseveralyearsofconstrainednewsupplyandrecord-low
levelsofnewhouseholdformationsuggestthatupside
surpriseispossible,especiallyinthetimingofwhenhome
pricesreachtheirlowsforthiscycle.
Inthecaseoffnancialstocks,thereisnodoubtthatthe
sectorbecametoolargeasaproportionoftheoverall
economy.Thereislikewisenodoubtthatthesectorhas
beenmassivelyrebalancing.AsaproportionoftheS&P
500,themarketcapitalizationoffnancialstocksdropped
from22.0%inDecember2006to13.6%inDecember2011.
(Sources:BloombergandPutnam.).
Figure 1. Sectors of the U.S. economy free from deleveraging have outperformed since 2008 and
continue to ofer opportunities.
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40
60
80
100
120
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7
Source:Putnam.ThetwohypotheticalportfoliosrepresentsectorsoftheRussell3000Index,withstocksgivenequalweightsandinitialportfolio
valuessetequalto100forcomparisonpurposes.Thedeleveragingportfoliorepresentsprimarilyrealestate,fnancial,andcertainhealth-careand
defenseindustriesconsideredtobeinfuencedtoasignifcantdegreebygovernmentspendingorregulation.Thenon-deleveragingportfoliorepre-
sentsallothersectors,suchasconsumer,technology,basicmaterials,capitalgoods,utilities,telecommunications,andenergy.
Non-deleveraging sectors
Deleveraging sectors
This deleveraging does
not affect all sectors of
the economy.
4
Q1 2012|Capital Markets Outlook
Regulation,intheformofDodd-Frankingeneral,andthe
Volckerruleinparticular,hassubduedtheproftabilityof
modernbankingactivities.Inturn,thishasledtomoney
centerbanksexitingbusinesslines,andlayingofthou-
sandsandthousandsofemployees.Whileitishardtotell
exactlyhowmuchrebalancingisrequired,webelieveitis
reasonabletosaythatasignifcantportionofthisadjust-
menthasalreadybeenmade.
Thedeleveragingofthegovernmentsectorbeganin2011.
Thisdeleveragingprocessmustcontinueforsometime
torestorenationalsolvency.Thatsaid,thepublicsector
hasluxuriesthattheprivatesectordoesnot,namely,the
powertotaxandthepowertoprintmoney.Thisfexibility
permitsthepublicsectortoimposeadjustmentsmuch
moregraduallythantheprivatesector.
In2012,theAmericanpeoplewillelectthenextpresidential
administration.Theoutcomeofthisvotewilldetermine,
inalllikelihood,whethernationalfnancesareaddressed
primarilythroughtaxhikesorthroughspendingcuts.Either
way,theadjustmentprocessisunlikelytobegininearnest
untilthenewadministrationassumespowerin2013.
Inanutshellthen,wethinktheexpandingsectorsofthe
U.S.economycancontinuetogrow,whilethedelever-
agingsectorsmayseepotentialupsidein2012.
Asset allocation choices in 2012 should focus
on geography
Assetallocationstrategycanbeorganizedacrossseveral
importantdimensionsassetclass,sector,investment
style,marketcapitalization,andgeography.Inmyexperi-
ence,theefcacyoftheserespectiveanalyticalstrategies
ebbsandfows.Forexample,thevalue-versus-growth
dimensionhascometomeanfarlesstodaythanitdida
decadeago.
As2012begins,wefndthedimensionofgeography
themostintriguing.Lately,ithasbecomefashionableto
describeworldequitymarketsasperfectlycorrelatedand
linkedbythepresenceorabsenceofriskappetite.This
descriptionftsthedatawhenviewedonaday-to-day
basis.However,alonger-termviewrevealsafardiferent
picture.Cumulativeperformancediferencesacrossstock
marketshavebeenstrikinglydissimilar,despitehighday-
to-daycorrelation.In2011,forexample,theMSCIWorld
Indexdeclinedby-5.5%.ButonlytheUnitedStates,the
UnitedKingdom,Ireland,andNewZealandperformedat
orabovethatlevel.Theremainderofthe24countriesin
thatindexdeclined,somebysignifcantmargins(Figure2).
Thisrefectsourbeliefthateconomicfortunesaroundthe
worldvaryconsiderablybyregion.Asfurtherevidence,at
theoutsetof2012EuropeisfacingarecessionwhileAsian
countriesappearreadytoreaccelerate.
Wethinkthatgeographyislikelytobequitemeaningful
againin2012.Europewillcontinuetostruggleagainstan
intensifyingdebtcrisis,andstepstakentoaddressthe
debtcrisiswillnecessarilysubdueeconomicactivitythere
asresourcesaredirectedawayfrommoreproductive
uses.Meanwhile,Asiancountriesingeneral,andChina
inparticular,appearpoisedforstrongergrowth.Equity
marketperformancecouldfollow,withleadership
returningtoemergingmarketsandtheUnitedStatesas
capitaliswithdrawnfromEuropeanddeployedinthese
moreattractiveareas.
Europe is facing a recession
while Asian countries appear
ready to reaccelerate.
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5
Asset class views
Equity
U.S. equityU.S.stockpricesandearningsdiverged
sharplyheadinginto2012,withstocksupmodestlyfor
theyearbutwithearningsup15%.Themoreconserva-
tivesectorswithintheS&P500Indexutilities,health
care,andconsumerstaples,forexampleattractedthe
lionsshareofinvestorsandsawsomeexpansionofprice
multiplesasaresult.Industriestiedmoredirectlytothe
economiccycle,includingindustrials,energy,andfnancial
stocks,sawvaluationsdeclinebyasmuchas40%.Allof
thissuggeststhat,forthemomentatleast,macroissues
arecontinuingtodominatethelandscapeforU.S.stocks.
Giventhatoverthelongrunstockpricestendtofollow
earnings,therearetwowaysthisdivergencecanberecon-
ciled.Thefrstisthatwhateverthemarketisworriedabout
comestofruition,andearningscomeunderafairamount
ofpressure.Thatscenariowouldnotbegoodforstocks,
butinsomesectorsthatoutcomemayalreadyberefected
incurrentvaluations.Theotherscenarioisthatthemacro
concernsstarttofadeandthatstockpricescatchupto
whatappearstobetrulydynamicandpowerfulearnings
growth.The$98consensusestimateof2011earningsper
sharefortheS&P500Index,arecord,isoutpacedonlyby
consensusestimatesfor2012astunning$106pershare.
Figure 2. Global market performance diverged signifcantly for 2011 as a whole, though markets moved
together on volatile days.
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Source:MSCI.
2011 global market performance, in local currencies
6
Q1 2012|Capital Markets Outlook
Asweenter2012,itiscleartheU.S.economyhassurprised
somebybeingmoresupportivethannot.Economists
werefearfulthatgrowthwoulddeceleraterapidlyafterthe
S&PdowngradeofU.S.debtinAugust.Butthatdidnot
happen,andeconomicdatahavegenerallysurprisedon
theupsideeversince.Housing,jobs,consumerconfdence,
andspendinghaveallimproved.Corporateproftabilityas
measuredbymarginsisquitehigh.Andwhilemarginstend
tohavemean-revertingcharacteristicslateinthecycleof
mosteconomicexpansionsascapacityutilizationtightens
andcompaniescompetetheirmarginslowerthereareno
signsthesepressuresareonthehorizontoday.Theeconomy
shouldremainsupportiveandself-sustaininginthecoming
quarter,evenifgrowthisslowerthanmanywouldlike.
Thereareofcourseahandfulofwell-knownexternal
variablestowatch,includingEuropescleareconomic
decelerationandChinasmoremeasuredslowdown.That
said,apartfromabriefperiodinearly2009,U.S.stocks
havenotbeenthischeapsincethe1980sandmaynow
refectahistoricentrypointforlong-terminvestors.
Non-U.S. equityInthefrstquarterof2012,weexpect
non-U.S.equitymarketstocontinuetobebufetedbyrisks
outofEurope,includingheavysovereignfundingsched-
ulesandcontinuedelevatedborrowingcostsforcountries
suchasPortugal,Italy,Ireland,Greece,andSpain.Our
basecaseisthattheEuropeanUnionislikelytomuster
thepoliticalwillandleveragethebackingoftheInterna-
tionalMonetaryFundinordertoremainintactthrough
thisperiodofmacroeconomicinstability.Havingsaidthat,
deterioratingeconomicconditionsinEuropeexacer-
batedbyEuropesneedforausteritywillhitperipheral
Europeancountriesrelativelyhardandmayputdownward
pressureonglobalgrowth.EuropeisChinaslargestexport
market,forexample,soEuropeanweaknesswouldnega-
tivelyafectChinasexportgrowth.Inaddition,market
observersmaycontinuetofretoverhowmuchaEuropean
recessionwhichmanyforecastersnowbelieveisallbut
inevitablewillafectrecoveryintheUnitedStates.
Japan,bycontrast,isnotasstronglytiedtothefateof
Europeasitistothecombinationofeconomicdevelopments
intheUnitedStatesandChina.Nevertheless,Japanese
equitymarketswillfaceimportantrisksas2012progresses,
includingthegradualfadingofthepost-earthquakerebound
andthelonger-termproblemofmassivegovernmentdebt
combinedwithpoordemographics.
Figure 3.Equities appear undervalued relative to robust corporate earnings.
0
500
1,000
1,500
2,000
12/31/11 12/31/05 12/31/00 12/31/95 12/31/90 12/31/85 12/31/80 12/31/75 12/31/70 12/31/65 12/31/60 1/31/54
$94.98
1,257.61
Sources:S&PandPutnam,asof12/31/11.Pastperformanceisnotindicativeoffutureresults.
Earnings per share ($), trailing 12 months
S&P 500 Index values
Corporate profitability as measured
by margins is quite high.
The European Union is likely to muster
the political will to remain intact.
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7
Intheemergingmarkets,wehaveseengovernmentpolicy
turnincreasinglysupportiveofgrowth,particularlyasthe
Europe-basedthreattoexport-ledgrowthhaswaxed
stronger.Europe,webelieve,willnotderailthelong-term
growthofemergingmarkets,theireconomicrebalancing
throughthedevelopmentofdomesticconsumption,or
theirseculartrendsofurbanizationandwealthcreation
amongarisingmiddleclass.
Intheinterim,weexpectpoliticaldevelopmentswilldrive
Europeanmarkets,withhope-fueledralliesfollowedby
fear-inducedsell-ofs.Earningswillbeunderpressure,and
stockswilllikelybechallengedtomakegains.However,
giventheprobabilityoflimitedgrowthintheeurozone,we
believethosecompaniesthatprovecapableofofering
sustainablegrowthwilllikelytradeatapremium.Inaddi-
tion,weexpectmonetaryeasinganddownward-trending
valuationsincertainareastoprovidedownsidesupport
tofaggingmarkets.Whatsmore,giventherightpolitical
outcome,theEuropeanCentralBankcouldachievea
reductioninsovereignborrowingcosts,whichwouldbe
aforcefultailwindforEuropeanequitiesandinternational
riskassetsmoregenerally.Nevertheless,theriskstothis
morepositivescenarioarereal,andausteritywillbedif-
culttobearbysomeeurozonecountries,justaswealthier
countriesmayfndthelevelofsupporttheyneedto
providetotheirweakerneighborsabitterpilltoswallow.
Fixed income
U.S. fxed incomeUncertaintyremainedhighinthe
fourthquarterasthelargemacroeconomicchallengesthat
dominatedheadlinesthroughout2011continuedtoweigh
oninvestorconfdence.TreasuryratesintheUnitedStates
declinedslightlyamidsoliddemand,whilediscussions
overreducingthesizeofthefederaldefcitcontinuedto
takecenterstageheadingintoelectionyear.Outsidethe
UnitedStates,littleprogressappearedtobemadeinthe
Europeansovereigndebtsituationdespiteongoingnego-
tiations.Non-Treasurybondmarketsinthefourthquarter
generallycontinuedtodecline,withmortgage-backed
securitiesinparticularstrugglingtoreversecourseafter
theirsignifcantsell-ofinthethirdquarter.Onebrightspot
wasfoundwithincorporatedebt,particularlyhigh-yield
bonds,whichralliedtocloseouttheyearafteradifcult
thirdquarter.
Aswehavestatedbefore,webelievethefundamentals
acrossarangeoffxed-incomesectorsremainattractive,
themacroeconomicchallengesfacingU.S.marketsnotwith-
standing.Defaultsincorporatedebtarewellbelowthe
long-termaverage,andwebelievethatthedefaultrateis
likelytoremainlow,eveninarelativelyweakeconomicenvi-
ronment.Meanwhile,2011corporateearnings,asmeasured
bytheS&P500,mayhitanall-timehigh,andwebelieve
thecombinationmakesacompellinginvestmentcase.
Withinthemortgage-backedsector,wecontinuetofnd
opportunitiesbothinnon-agencyresidentialmortgage-
backedsecuritiesandininterest-onlycollateralized
mortgageobligations.Webelievethatbothstrategiescan
performwellinanenvironmentofweakhousingprices;
interest-onlyCMOsbeneftfromhomeownerstaking
longertopaydownmortgagesandfromrefnancing
ratesremainingslow.Althoughrecentmodifcationsto
thegovernment-sponsoredHARP(HomeAfordable
RefnanceProgram)havepavedthewayforanincrease
inrefnancings,wefavorsecuritiestiedtolowerratesand
moreseasonedmortgages,whicharethereforelesslikely
toberefnanced.
Non-agencysecurities,meanwhile,shouldgenerate
attractivecashfowsevenifhousingpricescontinueto
struggle,ouranalysissuggests.Themainconcern,we
believe,isnotoneoffundamentals,butoftechnicals:
TheU.S.FederalReserveandEuropeanbanksbothhave
sizableexposurestonon-agencyRMBS,andshouldthe
marketsupplyincreasedramaticallyastheseentitiessell
theirpositions,itcouldundermineprices.Itisasituation
wearemonitoringclosely.
The fundamentals across a
range of fixed-income sectors
remain attractive.
8
Q1 2012|Capital Markets Outlook
Withregardtointerestrates,wecontinuetofavorlimited
exposuretointerest-raterisk,whichwebelieveofersvery
limitedupside.Withinterestratesinanumberofmarkets
nearhistoriclows,webelievethepotentialrewardsfrom
along-durationstanceareminimal.Thatsaid,webelieve
thereareopportunitiestotaketacticalpositionsatthe
longendoftheyieldcurve,whichwebelievewillcontinue
toexhibitvolatility.Whilecentralbankshaveanchored
theshortendofthecurve,thelongendrepresented
bybondswithmaturitiesof20or30yearsmaybe
forcedtoabsorballofthepolicyuncertaintyoranyaddi-
tionalshockstotheglobalfnancialsystem.Wecontinue
tomonitorthegloballandscapeforshort-termtactical
opportunities.
U.S. tax exemptAtthistimeoneyearago,headlines
predictingawaveofdefaultsinthemunicipalbondmarket
werecommon.Clearly,thosedefaultshavefailedtomate-
rialize.WecontinuetoviewA-andBaa-ratedessential
servicerevenuebondsinsectorssuchashighereducation
andutilitiesasattractiveopportunities.Whiletechnical
factorsinthemarkethavebeenpositivespecifcally,
lightersupplyandstabledemanduncertaintyremains.
Webelievethatstateswillcontinuetofacefnancialchal-
lengesastheeconomystrugglestofnditsfooting.For
themostpart,however,webelievethatthefscalcondi-
tionsofstatesandmunicipalitiesareshowingsignsof
improvement.Taxreceiptsarebeginningtoimprove,albeit
slowly,andwebelievedefaultswillremainrelativelylow.
Wewouldnotethatlocalgeneralobligationbondsremain
vulnerabletothelagefectsofdecliningpropertytaxes.
Ourprimaryconcernsremainfocusedontheeconomy
andCongresssplanstoreducethedefcit.Higherfederal
incometaxrates,achangeinthetaxstatusofmunicipal
bonds,orsignifcantcutsinstatefundingallwouldhave
consequencesforthemunicipalbondmarket.
States will continue to
face financial challenges
as the economy struggles
to find its footing.
Figure 4.U.S. Treasury yields have remained at low levels amid economic worries.
0
1
2
3
4
5
30
yrs
20
yrs
10
yrs
7
yrs
5
yrs
3
yrs
2
yrs
1
yr
Source:U.S.DepartmentoftheTreasury,asof12/31/11.Pastperformanceisnotindicativeoffutureresults.
6/30/11
9/30/11
12/31/11
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9
Non-U.S. fxed incomeEuropecontinuedtosetthetone
forglobalmarketsinthefourthquarter.Itisunlikelythata
simplesolutionexistsforaddressingthepolicychallenges
Europefacesgiventhedisparityoftheneedsandgoalsof
thepartiesinvolved,andinmanywaysmarketscurrently
refectthisreality.Forexample,thespreadbetween
ItalianandGermaninterestratestodaycloselymatches
thediferenceswesawinthepre-EuropeanMonetary
Unionera.Inthe1990s,thosediferencesweretheresult
primarilyofcurrencyrisks,whiletodaythosediferences
aredrivenbycreditrisks,andweconsideritunlikelytosee
ItalyborrowatGermanratesanytimeintheforeseeable
future.Giventhatoutlook,itisunclearwhattheincentive
isforsouthernEuropeancountrieslikeGreeceandItalyto
remaincommittedtoasingleEuropeancurrency,which
limitstheirpolicyoptionsfordealingwiththeirdebtloads.
Whilewebelievethefundingarrangementsputinplace
havelikelyhelpedtheEuropeanUnionavoidacrisisover
theshortterm,long-termfscalchallengesremain,andthe
outcomeappearsanythingbutcertain.
Withinemerging-marketdebt,webelieveinvestors
needtobecognizantofthedownsideriskspresentinthe
comingmonths.Overthepastseveralyears,wehave
seendeleveragingfrstinthehousingmarketandbanking
sectorsin2008,andthenagaininsovereignEuropein
2010,andwebelievethereisasignifcantriskthatcapital
outfowsinemergingmarketscouldgainsteamin2012.
Throughmostofthepast10years,emergingmarkets
beneftedfromlowinfation,balancedbudgetsorlow
defcits,consistentpolicies,stablegovernments,and,
ultimately,easyaccesstothecapitalmarkets.Since2008,
wehaveseenamuchmorevolatileanddiverselandscape
intheglobalbondmarkets,withabroaderrangeofpolicy
needsaroundtheworld:Somecountriesfacetherisk
ofoverheatingeconomicallyandareraisingrates,while
othersareseekingtowardofrecessionbyloosening
theirmonetarypolicies.Thatbackdropmaycreatesome
instabilityforemergingmarketsgenerally,asinternational
investorscouldpullcapitaloutofthesesmallandopen
economies,challengingemerging-marketcentralbanks
andpolicymakersinawaytheyhavenotbeenchallenged
in10yearsormore.Weremainbullishonthelong-term
fundamentalstoryinemergingmarkets,andbelievethe
near-termuncertaintyunderscorestheimportanceofthe
kindoffundamentalresearchandactivemanagement
Putnamofers.
Commodities
Investorsrelyinguponcommoditiesfordiversifcationof
stock-marketriskhavebeendisappointedinrecentyears.
Overthepastthreeyears,forexample,thecorrelation
betweentheS&P500andtheGoldmanSachsCommodity
Index(GSCI)hasmeasuredroughly0.6,makingcommodi-
tiesafairlyweakdiversifer.Itisnotunreasonable,then,to
beginouranalysisofcommoditiesbyconsideringthem
tobejustanotherriskasset.Doingsoallowsustorefne
ourforecastbaseduponuniquecircumstancesfacing
commoditiesrelativetootherriskassets.
Wefndthisapproachtobeparticularlyinstructiveas2012
begins.Therearekeydisadvantagesfacingcommodities.
Firstistheongoingissueofnegativerollyield,whichin
2011costthoseinvestedintheGSCImorethan3%oftheir
totalreturn.Whilethenegativecarryofcommoditieshas
becomelesssevereoverthepastyear,itremainsadistinct
disadvantagerelativetootherriskassets.Anotherpoten-
tialheadwindforcommoditiesisthedevelopingtrend
ofU.S.dollarstrength.Asmostcommoditiesarepriced
inU.S.dollars,commodityperformancetendstohavea
negativecorrelationtotheU.S.dollar.Overallthen,we
favoranunderweighttocommodities.
Withincommodities,wefavorenergyandpreciousmetals
asahedgeagainstgeopoliticalriskintheMiddleEast.Any
disruptiontooildistributionwouldtriggerrisingoilprices
andlikelyadeclineinriskappetite,whichcould,atleast
temporarily,supportgoldprices.
We remain bullish on the
long-term fundamental story
in emerging markets.
Another potential headwind for
commodities is the developing
trend of U.S. dollar strength.
10
Q1 2012|Capital Markets Outlook
Currency
Thefourthquarterbeganwithriskaversionatlevelsthat
dominatedallotherfactorsincurrencymarkets.The
promiseofprogressinEurope,coupledwithpositive
economicdatasurprisesinmostoftheG-10countries
outsidetheeurozone,helpedtheriskenvironmentrevert
tomoreneutrallevels.LiquidityprovisionsviaFederal
ReserveU.S.dollarswaplinesandaEuropeanCentral
Bank(ECB)facilityalsohelpedboostriskappetites.
WebelievetheU.S.dollarissupportedbyequityfows,
interest-ratemomentum(compressionofglobalratesto
U.S.rates),andthecurrentphaseoftheglobalgrowth
cycle.DespiteanimprovementinU.S.economicgrowth,
theFedhassignaledthatitwillevaluatefurthermeasures
ifthegrowthsituationworsens.Fortheforeignexchange
market,thelackoffurtherextensionoftheFedbalance
sheetentailsastrongerdollaragainstmarketswhererates
areexpectedtoconvergewithU.S.rates.
Wefavorthedollarovertheeuroasfnancialrisksarethe
mostacuteintheeurozone,whichmayalreadybeina
recession.TheECBremainsinthemidstofpoliticalbrink-
manship.Thisshouldkeeppressureonthesinglecurrency.
WefavorthedollaroverthepoundastheU.K.economy
mayalsobeheadingintoarecessionduetostrong
tieswiththeeurozone.TheBankofEnglandcontinues
toincreaseitsquantitativeeasing,whichshouldkeep
pressureonthepound.
Bycomparison,weareneutralontheyen.TheJapanese
haveintervenedinmarketstoweakentheyenversusthe
dollar,buttheUnitedStatessubsequentlyadmonished
theintervention.Intheseconditions,wefavortactical
fexibilitywiththesecurrencies.
MARKET TRENDS
Index name (returns in USD) 4Q11 12 months ended 12/31/11
EQUITIES
Dow Jones Industrial Average 12.44% 7.95%
S&P 500 Index 11.82 2.11
Nasdaq Composite Index 7.86 -1.80
Russell 2000 Index 15.47 -4.18
MSCI World Index (ND) 7.59 -5.54
MSCI EAFE Index (ND) 3.33 -12.14
MSCI Europe Index (ND) 5.39 -11.06
Tokyo TOPIX Index -5.61 -10.49
MSCI Emerging Markets Index (ND) 4.42 -18.42
FIXED INCOME
Barclays Capital U.S. Aggregate Bond Index 1.12% 7.84%
Barclays Capital 10-Year Bellwether Index 1.23 17.18
Barclays Capital Global Aggregate Bond Index ex-U.S. (unhedged) -0.36 4.36
JPMorgan Global High Yield Index 6.43 5.73
JPMorgan Emerging Markets Global Diversifed Index 4.65 7.35
COMMODITIES
Goldman Sachs Commodities Index 8.96% -1.18%
Itisnotpossibletoinvestdirectlyinanindex.Pastperformanceisnotindicativeoffutureresults.
Putnams veteran senior market
strategists review opportunities
and risks across global asset classes
The Investment Themes of Capital Markets Outlook
are developed by Putnams Global Asset Allocation
Team, one of the industrys largest and longest-tenured
groups dedicated to multi-asset strategies. The team
monitors global markets on an ongoing basis and each
quarter produces a comprehensive review of invest-
ment potential and risks. This rigorous research process
guides the teams management of Putnam Global Asset
Allocation Funds, Putnam RetirementReady Funds,
Putnam Retirement Income Lifestyle Funds, and Putnam
Absolute Return 500 Fund and 700 Fund.
Jefrey L. Knight, CFA
Head of Global Asset Allocation
James A. Fetch
Portfolio Manager
Robert J. Kea, CFA
Portfolio Manager
Joshua B. Kutin, CFA
Portfolio Manager
Robert J. Schoen
Portfolio Manager
Jason R. Vaillancourt, CFA
Portfolio Manager
The Asset Class Views refect the thinking of Putnams
sector research experts across global equity and fxed-
income markets, distilled through senior investment
leaders and portfolio managers across Putnam.
U.S. Equities
Robert D. Ewing, CFA
Co-Head of U.S. Equities
International Equities
Shep Perkins, CFA
Co-Head of International
Equities
Fixed Income
D. William Kohli
Co-Head of Fixed Income
Commodities
Jefrey L. Knight, CFA
Head of Global Asset Allocation
Currency
Robert L. Davis, CFA
Analyst
The Barclays Capital 10-Year U.S. Treasury Bellwether Index is an unmanaged
index of U.S. Treasury bonds with 10 years maturity.
The Barclays Capital U.S. Aggregate Bond Index is an unmanaged index used as a
general measure of U.S. fxed-income securities.
The Barclays Capital Global Aggregate Bond Index ex-U.S. (unhedged) is an
unmanaged index used as a broad measure of the investment-grade bond index,
excluding U.S. securities.
The Dow Jones Industrial Average Index (DJIA) is an unmanaged index composed
of 30 blue-chip stocks whose one binding similarity is their hugeness each has
sales per year that exceed $7 bil lion. The DJIA has been price-weighted since its
inception on May 26, 1896, refects large-cap companies representative of U.S.
industry, and historically has moved in tandem with other major market indexes
such as the S&P 500.
The Goldman Sachs Commodity Index is a composite index of commodity sector
returns that represents a broadly diversifed, unleveraged, long-only position in
commodity futures.
The JPMorgan Global High Yield Index is an unmanaged index that is designed
to mirror the investable universe of the U.S. dollar global high-yield corporate
debt market, including domestic (U.S.) and international (non-U.S.) issues.
International issues are composed of both developed and emerging markets.
The JPMorgan Emerging Markets Global Diversifed Index is composed of U.S.
dollar-denominated Brady bonds, eurobonds, traded loans, and local market debt
instruments issued by sovereign and quasi-sovereign entities.
The MSCI EAFE Index is an unmanaged list of equity securities from Europe and
Australasia, with all values expressed in U.S. dollars.
The MSCI Emerging Markets Index is a free-foat-adjusted market-capitalization-
weighted index that is designed to measure equity market performance in the
global emerging markets.
The MSCI Europe Index is an unmanaged list of equity securities originating in any
of 15 European countries, with all values expressed in U.S. dollars.
The MSCI World Index is an unmanaged list of securities from developed and
emerging markets, with all values expressed in U.S. dollars.
The Nasdaq Composite Index is a widely recognized, market-capitalization-
weighted index that is designed to represent the performance of Nasdaq securities
and includes over 3,000 stocks.
The Russell 2000 Index is an unmanaged list of common stocks that is frequently
used as a general performance measure of U.S. stocks of small and/or midsize
companies.
The Russell 3000 Index is an unmanaged index of the 3,000 largest U.S. compa-
nies. You cannot invest directly in an index.
The S&P 500 Index is an unmanaged list of common stocks that is frequently used
as a general measure of U.S. stock market performance.
The Tokyo Stock Exchange Index (TOPIX) is a market-capitalization-weighted
index of over 1,100 stocks traded on the Japanese market.
NOTES
The opinions expressed in this article represent the current, good-
faith views of the author(s) at the time of publication and are
provided for limited purposes, are not defnitive investment advice,
and should not be relied on as such. The information presented in
this article has been developed internally and/or obtained from
sources believed to be reliable; however, Putnam Investments
does not guarantee the accuracy, adequacy, or completeness of
such information. Predictions, opinions, and other information
contained in this article are subject to change continually and
without notice of any kind and may no longer be true after the
date indicated. Any forward-looking statements speak only as of
the date they are made, and Putnam assumes no duty to and does
not undertake to update forward-looking statements. Forward-
looking statements are subject to numerous assumptions, risks,
and uncertainties, which change over time. Actual results could
difer materially from those anticipated in forward-looking state-
ments. Past performance is not a guarantee of future results. As
with any investment, there is a potential for proft as well as the
possibility of loss.
The information provided relates to Putnam Investments and its
afliates, which include The Putnam Advisory Company, LLC and
Putnam Investments Limited.
Prepared for use in Canada by Putnam Investments Inc.
[Investissements Putnam Inc.] (o/a Putnam Management in
Manitoba). Where permitted, advisory services are provided in
Canada by Putnam Investments Inc. [Investissements Putnam
Inc.] (o/a Putnam Management in Manitoba) and its afliate, The
Putnam Advisory Company, LLC.
Diversifcation does not assure a proft or protect against loss. It is
possible to lose money in a diversifed portfolio.
In the United States, mutual funds are distributed by Putnam Retail Management.
putnam.com CM01002708811/12
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