October 23 2009 pe: Portfolio Strategy On our way from Hope to Growth The European market is currently in the Hope phase this phase typically lasts 10 months from the trough, seeing expansion of the multiple while LTM earnings are still declining. The range has been from 4 months in the short cycle in the late 1980s to 18 months in the cycle in the early 1980s. We expect earnings to decline 16% in 2009, yet the market is up 25% YTD and we expect the market to rise another 5% from here to our year- We expect the market to switch into the growth phase in the early part of 2010, as earnings growth picks up while our return target of 275 on a 12 month basis indicates only a modest rise in the index of 6% from our 260 year-end 2009 target Our prediction of the timing of the switch from Hope to growth comes with significant uncertainty. On one hand, valuation at the trough of the market was very attractive. This could give room for a longer period of multiple expansion before the switch to the growth phase occurs, consistent with the cycle in the early 1980s. On the other hand given the concerns in the market about final demand recovery in developed economies, we could switch into the"show me the money"environment of the growth phase relatively early Our forecast of the timing of the switch from Hope to growth is based on the economic environment. There is no one economic indicator that precisely determines when the switch occurs, but the PMi and the unemployment rate have historically been useful indicators the switch fror time when the Pmi passed 50. this is consistent with the US experience, where our data goes further back. Here a sustained switch into the ISM being above 50 has coincided with the switch to the growth phase in 3 out of 5 cycles. The European PM is currently at 49. 3, so we are around that level Unemployment: In the cycles in the 1970s and early 1980s the unemployment rate peaked in the Us before the market switched into the growth phase. this relationshi hanged in the last two jobless recoveries, where the switch from Hope to growth ccurred at or slightly before the peak in the unemployment rate. In Europe the same picture emerges for the last two cycles where we have data On our economists forecasts the unemployment rate for Euroland will peak in the third quarter of 2010 at 10.5%, but reach 10.4% in the second quarter of 2010 In sum the PMi would suggest that the switch is likely to occur relatively soon whereas the unemployment forecast would suggest the timing to be around the middle of the next year this range is consistent with our forecasts for earnings and DJ Stoxx index returns. We believe the switch is most likely to occur in the first half of the range, which would give a slightly longer Hope phase than the historical average oldman Sachs Global Economics, Commodities and strategy ResearchOctober 23, 2009 Europe: Portfolio Strategy Goldman Sachs Global Economics, Commodities and Strategy Research 4 On our way from Hope to Growth The European market is currently in the Hope phase. This phase typically lasts 10 months from the trough, seeing expansion of the multiple while LTM earnings are still declining. The range has been from 4 months in the short cycle in the late 1980s to 18 months in the cycle in the early 1980s. We expect earnings to decline 16% in 2009, yet the market is up 25% YTD and we expect the market to rise another 5% from here to our year￾end target of 260. We expect the market to switch into the Growth phase in the early part of 2010, as earnings growth picks up while our return target of 275 on a 12 month basis indicates only a modest rise in the index of 6% from our 260 year-end 2009 target. Our prediction of the timing of the switch from Hope to Growth comes with significant uncertainty. On one hand, valuation at the trough of the market was very attractive. This could give room for a longer period of multiple expansion before the switch to the Growth phase occurs, consistent with the cycle in the early 1980s. On the other hand, given the concerns in the market about final demand recovery in developed economies, we could switch into the “show me the money” environment of the Growth phase relatively early. Our forecast of the timing of the switch from Hope to Growth is based on the economic environment. There is no one economic indicator that precisely determines when the switch occurs, but the PMI and the unemployment rate have historically been useful indicators. • PMI: In the last cycle the switch from Hope to Growth in Europe occurred around the time when the PMI passed 50. This is consistent with the US experience, where our data goes further back. Here a sustained switch into the ISM being above 50 has coincided with the switch to the growth phase in 3 out of 5 cycles. The European PMI is currently at 49.3, so we are around that level. • Unemployment: In the cycles in the 1970s and early 1980s the unemployment rate peaked in the US before the market switched into the Growth phase. This relationship changed in the last two jobless recoveries, where the switch from Hope to Growth occurred at or slightly before the peak in the unemployment rate. In Europe the same picture emerges for the last two cycles where we have data. On our economists’ forecasts the unemployment rate for Euroland will peak in the third quarter of 2010 at 10.5%, but reach 10.4% in the second quarter of 2010. In sum, the PMI would suggest that the switch is likely to occur relatively soon, whereas the unemployment forecast would suggest the timing to be around the middle of the next year. This range is consistent with our forecasts for earnings and DJ Stoxx index returns. We believe the switch is most likely to occur in the first half of the range, which would give a slightly longer Hope phase than the historical average