October 23 2009 pe: Portfolio Strategy The 1970s cycle in charts: a tough cycle for equity markets The cycle in the 1970s was the worst of the five cycles we consider in Continental Europe, the UK and the Us from an equity market perspective. Multiple contraction over the cycle ranging from 42% in the UK to 52% in the US overpowered earnings growth ind led to negative price returns over the cycle for all three markets The poor market performance reflected the large supply-side shock from higher oil prices and the inflationary process initiated by this shock getting out of control Generally cycles where the initial setback is driven by structural problems tend to have longer growth phases than other cycles, as it takes longer for investors to regain the confidence that makes them willing to pay more for earnings and therefore move the market into the optimism phase. this is particularly pronounced in the US where the growth phase in the 1970s was the longest on record The end of the cycle includes the first part of the double dip recession in the early 1980s for the Us but not in Continental Europe and the UK. We have done this as the Us index recovered enough between the two dips to make up the lost ground from the first dip whereas this did not happen in Europe Exhibit 6: Division of the 1970s cycle into phases for Europe ex UK Europe ex UK Cumulative Change -Despair- Grow th. 100 80 Mar-73 Mar-74 Mar-78 US Recessions -Returns End date07/101974150419751507/197720101978 Length(in months) 15.2 39 12.9 Eamings Growth 48.9 P/E expansion Proportion of return ( Annualized 38.5 Earnings Growth Change in real interest rate (pp) 1.0 Analytics,Datastream,Goldman Sachs Global ECS. Goldman Sachs Global Economics, Commodities and strategy ResearchOctober 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 8 The 1970s cycle in charts: A tough cycle for equity markets The cycle in the 1970s was the worst of the five cycles we consider in Continental Europe, the UK and the US from an equity market perspective. Multiple contraction over the cycle ranging from 42% in the UK to 52% in the US overpowered earnings growth and led to negative price returns over the cycle for all three markets. The poor market performance reflected the large supply-side shock from higher oil prices and the inflationary process initiated by this shock getting out of control. Generally cycles where the initial setback is driven by structural problems tend to have longer growth phases than other cycles, as it takes longer for investors to regain the confidence that makes them willing to pay more for earnings and therefore move the market into the optimism phase. This is particularly pronounced in the US where the growth phase in the 1970s was the longest on record. The end of the cycle includes the first part of the double dip recession in the early 1980s for the US but not in Continental Europe and the UK. We have done this as the US index recovered enough between the two dips to make up the lost ground from the first dip, whereas this did not happen in Europe. Exhibit 6: Division of the 1970s cycle into phases for Europe ex UK Europe ex UK 20 40 60 80 100 120 140 160 180 200 Mar-73 Mar-74 Mar-75 Mar-76 Mar-77 Mar-78 US Recessions Returns Earnings PE Cumulative Change <---------Despair------> <--------------Grow th-------------> <Hope> <-----Optimism-----> Despair Hope Growth Optimism Start date 22/03/1973 07/10/1974 15/04/1975 15/07/1977 End date 07/10/1974 15/04/1975 15/07/1977 20/10/1978 Length (in months) 18.5 6.2 27.0 15.2 Real Return -52.8 39.8 12.9 13.0 Real Earnings Growth 19.6 1.2 48.9 -8.8 P/E expansion -60.5 38.1 -24.1 23.9 Proportion of return (%) 60.5 19.7 19.8 Annualized Real Return -38.5 90.4 5.6 10.1 Earnings Growth 12.3 2.4 19.3 -7.0 Change in real interest rate (pp) 0.7 -2.0 -2.3 1.0 Source: Worldscope, Haver Analytics, Datastream, Goldman Sachs Global ECS Research