October 23 2009 Europe: Portfolio Strategy man The equity cycle part 1: sans Identifying the phases The equity cycle is divided in 4 distinct phases Peter Oppenheimer The equity market moves in cycles. In order to develop a frame of +44(20)7552-5782ipeter.oppenheimer@gs.com reference for investors, we show how the cycle from one peak of the Goldman Sachs Internation market to the next is divided into four distinct phases, which we describe as: Despair, Hope, Growth and Optimism. Here, in Part I of thisChristian Mueller-Glissmann,CFA seriesweanalyzetheeconomiccontextandthedriversofstockmarketglissmann@gs.com returns for each phase. In Part ll, we will analyze asset, style and sector Goldman Sachs International performance. We believe Europe is currently in the Hope phase and will move into the growth phase in the early part of 2010 Gerald I +44(20)7774-5725geraldmoser@gs.com Goldman Sachs International We analyze when earnings growth is paid for Most earnings growth is not paid for when it occurs during the Growth Anders Nielsen +44(20)7552-3000anders.e.nielsen@gs.com phase, but when it is correctly anticipated during the Hope phase, and Goldman Sachs Interna tional when investors get overly optimistic about the future growth potential during the Optimism phase. The Growth phase sees the highest rate of Sharon Bell,CFA earnings growth, but the second lowest rate of return over the cycle Goldman Sachs Internation and tie these patterns to the economic cycle The phases are related to the economy. Generally the Despair phase is associated with a recession. The output gap troughs and the unemployment rate peaks during the Hope phase, while the growth phase sees sharp improvements in both variables. Investors real required return rises during the despair and growth phases and falls during the Hope and Optimism phases Decomposition of returns into earnings growth and P/E expansion Real earnings growth(%) Average P/E multiple expansion (% Real price retums ( 50 24.2% 27.1% 0.9% 2.3% -9.5% 19% 30 Despai 0 months mm→: optimism 14 months Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research man Sachs G Inm dv hs ve d seen'sicto o tesis sh at ith ua afect h e opered ivititsr heare ports. as a re y registered/qualified as research analysts w Goldman Sachs Global Economics, Commodities and strategy ROctober 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 1 Europe: Portfolio Strategy The equity cycle part 1: Identifying the phases The equity cycle is divided in 4 distinct phases The equity market moves in cycles. In order to develop a frame of reference for investors, we show how the cycle from one peak of the market to the next is divided into four distinct phases, which we describe as: Despair, Hope, Growth and Optimism. Here, in Part I of this series, we analyze the economic context and the drivers of stock market returns for each phase. In Part II, we will analyze asset, style and sector performance. We believe Europe is currently in the Hope phase and will move into the Growth phase in the early part of 2010. We analyze when earnings growth is paid for Most earnings growth is not paid for when it occurs during the Growth phase, but when it is correctly anticipated during the Hope phase, and when investors get overly optimistic about the future growth potential during the Optimism phase. The Growth phase sees the highest rate of earnings growth, but the second lowest rate of return over the cycle. …and tie these patterns to the economic cycle The phases are related to the economy. Generally, the Despair phase is associated with a recession. The output gap troughs and the unemployment rate peaks during the Hope phase, while the Growth phase sees sharp improvements in both variables. Investors’ real required return rises during the Despair and Growth phases and falls during the Hope and Optimism phases. Decomposition of returns into earnings growth and P/E expansion -30 -20 -10 0 10 20 30 40 50 60 Real earnings growth (%) Average P/E multiple expansion (%) Real price returns (%) 26 months 10 months 33 months 14 months Despair Hope Growth Optimism -24.9% -7.3% 51.2% 0.7% 10.9% 22.5% 27.1% 24.2% -19% 50.2% -9.5% 2.3% Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research. Peter Oppenheimer +44(20)7552-5782 | peter.oppenheimer@gs.com Goldman Sachs International Christian Mueller-Glissmann, CFA +44(20)7774-1714 | christian.mueller￾glissmann@gs.com Goldman Sachs International Gerald Moser +44(20)7774-5725 | gerald.moser@gs.com Goldman Sachs International Anders Nielsen +44(20)7552-3000 | anders.e.nielsen@gs.com Goldman Sachs International Sharon Bell, CFA +44(20)7552-1341 | sharon.bell@gs.com Goldman Sachs International The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification, see the end of the text. Other important disclosures follow the Reg AC certification, or go to www.gs.com/research/hedge.html. 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