stagflation versus valuation

8/14/2019 Stagflation Versus Valuation

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Lehman Brothers | Global Strategy Weekly

27 June 2008 1

Investment Strategy & MacroPortfolio Strategy

Global Strategy WeeklyMARKET SELECTOR

Stagflation versus valuation 2-5Ian Scott

The phenomenon that could have undermined our bullish call has undermined it.Stagflation is not just a journalistic debating point, but its effects are reflected inequity valuations. As much as we might protest that the environment is verydifferent from 1974 and 1978, relative equity valuations are at those historic levels.

With oil at $140 per barrel, global oil consumption accounts for nearly 7% of world GDP, a similar proportion to the peak reached in the early 1980s.

Returning to that era, the equity market consequences of the tripling in oil pricesand subsequent global recession, while not good, were heavily mitigated by theextremely low valuations that stocks traded on during that period.

We believe the same can be said for the current period.

While our in-house forecasts indicate a fall in crude prices is likely which should prompt a rally in the market, even without a large drop in prices, some stability,coupled with the extreme valuations on offer, should be enough to allow equities torecover.

Global Equity Research 27 June 2008

Regulars

Recommended Portfolio 6

Global Index Targets 7

Recommended Weightings 8

On-going Stylistic Themes 9

Databank

Market Performance 10

Sector Performance 10

Style Performance 10

Valuation and Profitability 11

Research Library 13

Please see our website athttps://live.lehman.com/go/keyword/eqs

Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware interest that could affect the objectivity of this report.Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covere where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-2LEHMANInvestors should consider this report as only a single factor in making their investment decision. This research report has been prepared in whole or in part by research analysts that are not registered/qualified as research analysts with

PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES INCLUDING FOREIGN AFFILIATE DISCLOSURES BEGINNING ON PAGE 15


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27 June 2008 2

MARKET SELECTOR

Stagflation versus valuationThe one combination of factors that could have undermined our positive outlook for stocks in 2008 has undermined it. While we might argue that the current environment isa world away from that which prevailed in 1974 or indeed 1978, market prices tell adifferent story. Stocks are as cheaply priced now as they were then, relative to risk-freerates, which suggests that stagflation is no longer viewed as a possibility, but a

probability by equity investors.

Figure 1: Global Earnings Yield Gap 1

-4

-2

0

2

4

6

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08

Yield Gap (% Points)

1 Trailing Earnings Yield less 10 year Global Treasury Yield (equity market cap weighted)Source: MSCI, Datastream, Lehman Brothers

Oil is, of course, the main issue. Crude price movements have been responsible for largeequity de-ratings in the past, and the same factor would appear to be happening now.With oil demand inelastic to price, at least in the short term, and the importance of oil as

both an input into the production process and as a consumer good, we believe it is theone commodity with the capacity to derail the global economy unilaterally, and within it,corporate profitability.

Figure 2: Global Oil Consumption as % of World GDP 1

0

1

2

3

4

5

6

7

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

%

1 2008 plot takes current spot rate of $140 as basis for calculationSource: BP Statistical Review of World Energy 2008, IMF, Datastream

Ian ScottTel: +44 (0)20 7102 2959

[email protected]

Stagflation fears are behind equities de-rating....

... and oil prices are behind those stagflation fears

If crude were to stay at $140,oil consumption would once

again account for almost 7 %of world GDP


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27 June 2008 3

Certainly, with crude at $140 per barrel, the world will once again spend nearly 7% of aggregate GDP on oil: a return to the peak levels of expenditure seen in the early 1980s.This was responsible for subsequent severe recessions in most developed economies, butit is also true to say that the extreme levels of value on offer during the period werefollowed by strong stock market performance. This environment of extreme valuation

coupled with extreme economic conditions meant that market dynamics were key.

Figure 3: Global Equity Prices and Crude Prices, Jan 78 to Dec 84

70

90

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190

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78 79 80 81 82 83 845

10

15

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45$ per barrel

Crude Price (RHS)

Equity Price (LHS)

Jan 1978 = 100

Source: FTSE, Datastream

If we examine the 1980s analogue, given that the overall effect of higher crude prices(as a percentage of global GDP) is on a par with the current environment, then it is clear to us that the rise in crude between 1978 and 1980 was accompanied by higher stock markets, but once growth slowed, stocks fell by 17% (peak to trough), between April1981 and March 1982, subsequently recovering as growth resumed.

Figure 4: Global Equity Prices and Industrial Output Growth, Jan 78 to Dec 84

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78 79 80 81 82 83 84-6

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10year-on-year

Equity Price (LHS)

Industrial OutputGrowth (RHS)

Jan 1978 = 100

Source: FTSE, OECD

Interest rates did not determine the turning point for stocks in 1982; bond yields hadalready been falling for a year.

Global equities rose between1978 and 1980 despite crude prices going up threefold (in

real terms they flat-lined)

Despite a protracted recession the largest decline

during the period was 17%

between April 1981 and March 1982


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27 June 2008 4

Figure 5: Global Equity Prices and Short Rate Movements, Jan 78 Dec 84

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150170

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78 79 80 81 82 83 846

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15% yield

Equity Price (LHS)

Global 10 year yield (RHS)

Jan 1978 = 100

Source: FTSE, Lehman Brothers

But, despite the similarities in terms of valuation and the link to crude, underlyinginflation is much lower now and labour markets more flexible. As we have demonstrated

before, US unit labour cost growth has been quick to adjust to the weakening demand for labour.

Figure 6: US Unit Labour Cost Growth

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0

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71 76 81 86 91 96 01 06

% year-on-year

Source: BLS

Core inflation has not demonstrated, so far, the feared second-round effects of higher food and energy prices. In prior cycles, both unit labour costs and core inflation werefaster to respond to the higher oil prices.

Our conclusion is that valuations protected stocks

from the worst ravages of the1978 1982 oil price shock

and subsequent recession


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27 June 2008 5

Figure 7: US and Euro Area Headline Inflation

0

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1970 1975 1980 1985 1990 1995 2000 2005

US

OECD Europe

y/y%

Source: OECD

So, while it is easy to see why the market is so fearful of higher crude prices as historyhas shown us this time round, it is hard to argue that things are as bad as they were ineither the mid 1970s or early 1980s. Yet relative valuations are as extreme.

We believe the best catalyst for stocks right now is a drop in crude. Our in-houseforecast suggests prices will decline to $110 by the year-end and average $93 next year.If this comes to pass, then the currently attractive valuations on offer will translate into asignificant rally, in our view. The more challenging question is whether the currentvalue, alone, is enough. As the analysis above suggests, in the past, value has beenenough.


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27 June 2008 6

GLOBAL RECOMMENDED PORTFOLIO

Price ($) Mkt Cap Calendarised EPS y/e DecPrice/

earnings DateRel Perf.

sinceRel Perf.

Over Analyst Sector Sector Stock Currency 25 Jun 08 US$m 2007e 2008e 2009e Dec 08 (x) Added Added 4 week 4 Rating 1 Rating 2

North America Overweight Recommended Weight 52% Benchmark Weigh 47%

Consumer Cyclicals COACH INC USD 30.5 10423.3 1.7 2.2 2.6 13.7 11 Dec 06 -32 -4 1-OW 2DOLLAR TREE INC USD 34.3 3083.1 2.1 2.4 2.6 14.6 10 Dec 07 28 -2 1-OW 2

WAL-MART STORES INC USD 58.1 172374.8 3.1 3.4 3.8 16.9 31 Mar 08 10 3 1-OW 2Energy CHEVRON CORP USD 99.4 205514.9 8.4 11.6 11.7 8.6 11 Dec 06 38 2 1-OW 2Financials & Insurance CHUBB CORP USD 51.1 18665.5 6.4 6.1 5.9 8.4 11 Dec 06 -2 0 1-OW 2

CITIGROUP INC USD 18.9 101495.9 0.7 0.4 2.7 53.9 20 Aug 07 -58 -6 1-OW 1JPMORGAN CHASE & CO USD 37.9 128315.2 4.4 2.9 3.8 13.0 11 Dec 06 -20 0 1-OW 1METLIFE INC USD 56.4 39961.6 6.3 6.2 6.9 9.1 14 Jan 08 -1 1 1-OW 2WACHOVIA CORP USD 17.9 38592.5 3.4 1.6 2.8 11.2 6 Nov 06 -71 8 1-OW 1

Health Care THERMO FISHER SCIENTIF USD 55.8 23452.2 2.7 3.2 3.7 17.7 11 Dec 06 22 -2 1-OW 1BRISTOL-MYERS SQUIBB C USD 20.3 39955.5 1.5 1.7 2.0 12.2 10 Dec 07 -17 5 1-OW 1CELGENE CORP USD 62.0 27003.7 1.1 1.5 2.3 41.3 14 Jan 08 20 5 1-OW 2MEDCO HEALTH SOLUTIONS USD 46.4 23488.7 1.8 2.3 2.7 20.2 14 Jan 08 -4 3 1-OW 2

Technology CISCO SYSTEMS INC USD 24.7 147236.6 1.3 1.6 1.8 15.3 10 Dec 07 1 0 1-OW 1COMMSCOPE INC USD 53.8 3758.3 2.8 3.4 4.1 16.0 10 Dec 07 24 1 1-OW 2HEWLETT-PACKARD CO USD 45.6 112417.6 2.9 3.6 4.1 12.5 4 Sep 00 -2 0 NR 2INTL BUSINESS MACHINES USD 124.6 171665.7 7.1 8.5 9.6 14.6 9 Jun 08 6 1 1-OW 2JUNIPER NETWORKS INC USD 23.3 12168.9 0.9 1.1 1.4 20.6 11 Dec 06 12 5 1-OW 1MICROSOFT CORP USD 28.4 2 65795.2 1.5 2.0 2.3 14.0 9 Jun 08 0 2 2-EW 1ORACLE CORP USD 22.6 115926.5 1.3 1.4 1.6 16.1 3 Apr 06 49 2 1-OW 1

Media DIRECTV GROUP INC USD 26.3 22627.5 1.2 1.5 1.9 17.7 14 Jan 08 29 -1 1-OW 2YAHOO INC USD 22.0 22711.6 0.5 0.5 0.6 45.9 11 Dec 06 -20 -2 2-EW 2OMNICOM GROUP USD 46.4 14875.8 3.0 3.4 3.7 13.7 14 Jan 08 10 2 1-OW 2

Telecoms AMERICAN TOWER CORP USD 42.7 16899.9 0.1 0.5 0.7 90.8 11 Dec 06 10 -1 1-OW 1AT&T INC USD 34.5 204786.3 2.8 3.0 3.4 11.4 11 Dec 06 1 0 1-OW 1

Europe Ex UK Underweight Recommended Weight 12% Benchmark Weigh 21%Consumer Cyclicals DAIMLER AG EUR 66.1 68063.9 7.3 9.2 10.4 7.2 25 Feb 08 -15 -3 2-EW 2

LVMH MOET HENNESSY EUR 105.8 38857.6 6.6 7.2 8.0 14.7 11 Dec 06 3 -3 1-OW 3PEUGEOT SA EUR 55.0 9662.8 6.0 9.6 11.2 5.7 25 Feb 08 -24 -1 1-OW 2RENAULT SA EUR 87.3 18035.8 16.1 16.2 19.8 5.4 25 Feb 08 -11 1 1-OW 2

Energy MAIRE TECNIMONT SP EUR 7.2 2326.7 0.4 0.5 0.5 15.0 7 Apr 08 52 7 1-OW 1TOTAL EUR 81.4 194772.6 8.4 9.8 10.3 8.3 14 Jan 08 2 4 1-OW 1

Financials & Insurance ALLIED IRISH BANKS EUR 15.5 13630.2 3.2 3.2 3.2 4.8 20 Aug 07 -35 -5 1-OW 1AXA EUR 32.0 66029.4 4.3 4.3 4.7 7.5 11 Jan 99 -42 0 1-OW 1BBVA(BILB-VIZ-ARG) EUR 20.2 75570.0 2.3 2.6 2.9 7.8 10 Dec 07 -7 1 1-OW 1BNP PARIBAS EUR 95.1 86066.3 13.2 12.5 13.6 7.6 30 Aug 07 -3 1 1-OW 1CREDIT SUISSE GRP CHF 46.9 54471.2 7.8 2.3 6.3 20.1 7 Apr 08 -22 0 2-EW 1INTESA SANPAOLO EUR 5.8 51146.5 0.5 0.7 0.8 8.4 20 Aug 07 -15 1 NR NRNATL BK OF GREECE EUR 45.6 22634.0 4.8 5.6 6.7 8.2 20 Aug 07 -10 -4 1-OW 1UNICREDIT SPA EUR 6.4 63880.0 0.8 0.8 0.9 8.1 20 Aug 07 -17 4 1-OW 1

Health Care ROCHE HLDGS AG CHF 169.1 118795.8 10.9 11.3 12.7 15.0 24 Jul 07 4 3 1-OW 2Technology CAP GEMINI EUR 60.7 8752.3 4.7 5.4 5.8 11.3 30 Oct 06 6 -3 1-OW 2Media PUBLICIS GROUPE SA EUR 34.2 4986.2 3.4 3.4 3.6 10.0 26 Mar 07 -27 -1 1-OW 1

VIVENDI SA EUR 38.5 44848.7 3.8 4.0 4.5 9.7 19 Jan 04 15 -1 1-OW 1Telecoms EUTELSAT COMMUNICA EUR 28.9 6345.4 1.1 1.3 1.4 21.8 7 Apr 08 7 1 1-OW 3

TELE2 AB SEK 19.1 7759.5 0.4 1.2 1.4 16.6 10 Dec 07 4 -1 1-OW 3

United Kingdom Underweight Recommended Weight 7% Benchmark Weigh 9%

Consumer Cyclicals MARKS & SPENCER GP GBP 6.9 10936.3 0.9 0.8 0.8 8.6 10 Dec 07 -30 5 1-OW 1NEXT GBP 20.2 4048.6 3.3 3.1 3.2 6.5 28 Jan 08 -23 5 1-OW 1PERSIMMON GBP 6.7 2016.7 2.7 1.4 1.2 4.7 28 Jan 08 -56 -8 NR NR

Consumer Stables TESCO GBP 7.5 59020.8 0.5 0.6 0.6 13.6 7 Apr 08 -2 2 1-OW 2Financials & Insurance BARCLAYS GBP 6.3 42623.9 1.3 1.2 1.3 5.5 04 Jul 05 -60 4 2-EW 1

MAN GROUP GBP 12.3 21010.5 0.9 0.9 0.9 13.5 13 Dec 04 149 4 1-OW 1OLD MUTUAL PLC GBP 1.9 10090.6 0.4 0.4 0.4 5.0 7 Apr 08 -18 -8 1-OW 2PRUDENTIAL GBP 11.6 28758.4 1.5 1.5 1.7 7.5 23 Oct 00 -22 -1 1-OW 2STANDARD CHARTERED GBP 30.9 43858.8 2.0 2.3 2.7 13.3 20 Aug 07 6 4 1-OW 1

Media WPP GROUP GBP 9.9 11722.0 0.9 1.0 1.1 9.9 10 Dec 07 -9 -6 1-OW 1

Japan Overweight Recommended Weight 14% Benchmark Weigh 9%

Capital Goods DAIKIN INDUSTRIES JPY 52.2 11484.2 2.4 2.6 2.9 20.2 10 Dec 07 11 -3 2-EW 2TADANO LTD JPY 10.8 1399.7 0.8 0.8 0.9 13.0 10 Dec 07 6 -1 1-OW 2

Consumer Cyclicals MITSUBISHI MOTOR C JPY 1.8 7501.9 0.1 0.0 0.0 45.3 10 Dec 07 12 -3 3-UW 2MITSUI O.S.K.LINES JPY 13.9 12555.1 1.5 1.6 1.6 8.8 10 Dec 07 16 1 NR NRKONICA MINOLTA HLD JPY 17.3 6898.0 1.2 1.2 1.3 14.2 10 Dec 07 3 -7 2-EW 2

Financials & Insurance MITSUI FUDOSAN CO JPY 21.7 19151.7 0.9 1.0 1.1 21.8 10 Dec 05 -3 -3 NR NRMIZUHO FINL GP JPY 4835.7 41331.3 234.6 396.0 461.6 12.2 28 Nov 05 -56 -7 2-EW 3NOMURA HOLDINGS JPY 15.2 29783.6 -0.3 0.6 1.0 24.3 14 Mar 05 -27 -5 1-OW 1SUMITOMO TRUST&BKG JPY 7.0 8801.0 0.5 0.5 0.6 13.1 8 Oct 07 -2 -10 2-EW 3

Health Care DAIICHI SANKYO COM JPY 26.2 14449.8 1.3 1.2 1.3 22.8 14 Jan 08 -12 -2 1-OW 3TERUMO CORP JPY 50.9 8057.4 2.0 2.2 2.4 23.6 10 Dec 07 8 2 NR NR

Technology SONY CORP JPY 45.5 45363.4 3.4 2.9 3.1 15.8 11 Dec 06 11 -7 NR NR

Asia Ex Japan Overweight Recommended Weight 12% Benchmark Weigh 9%

Capital Goods CHEUNG KONG INFSTR HKD 4.3 1957.7 0.3 0.3 0.3 14.7 10 Dec 07 28 5 1-OW 1Energy SINOPEC S/PETROCHE HKD 0.4 5880.0 0.0 0.0 0.0 50.1 11 Dec 06 -26 -10 2-EW 2

PETROCHINA CO HKD 1.3 3 99924.6 0.1 0.1 0.1 11.8 14 Jan 08 -15 0 2-EW 2Financials & Insurance HANG SENG BANK HKD 20.6 15781.2 1.2 1.2 1.3 17.8 10 Dec 07 14 6 NR NR

IND & COM BK CHINA HKD 0.7 251845.8 0.0 0.1 0.1 14.1 11 Dec 06 35 1 1-OW 1PUNJAB NATL BANK INR 9.9 3125.4 NA NA 2.0 NA 10 Dec 07 -27 -5 1-OW 1SUN HUNG KAI CO HKD 0.8 1362.1 0.2 0.1 0.1 7.2 10 Dec 07 -29 1 1-OW 1

Telecoms DIGI.COM.BERHAD MYR 7.5 5631.3 0.4 0.5 0.5 16.0 10 Dec 07 15 4 1-OW 1SINGAPORE TELECOMM SGD 2.7 17408.0 0.2 0.2 0.2 15.0 14 Jan 08 3 2 1-OW 1

Latin America / Other EMG Underweight Recommended Weight 1% Benchmark Weigh 4%

Financials & Insurance BK PEKAO PLN 78.9 20670.2 5.7 6.9 7.6 11.4 10 Dec 07 -9 5 1-OW 1T IS BANKASI TRY 3.7 10195.3 0.5 0.6 0.7 6.2 14 Jan 08 -31 -3 1-OW 1

Source: I/B/E/S, XShare, FactSet

Portfolio perf. (US$ terms, %) YTD Last Week 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997LB Strategy Recommend Portfolio -8.32 -1.91 6.90 12.92 11.10 11.87 33.69 -23.80 -13.80 -2.80 40.80 35.7 20.1FTSE-World Index -8.85 -1.92 11.74 18.82 8.87 13.66 30.97 -20.60 -17.50 -12.20 24.20 22.8 13.6

1 Analyst rating refers to Lehman Brothers research dept rating: "1 - OW" = Overweight; "2 - EW" = Equal Weight; "3 - UW" = Underweight, "NR" = Not Rated, "RS" = Rating Suspended.2 Sector rating refers to Lehman Brothers research dept sub sector rating: "1" = Positive; "2" = Neutral; "3" = Negative.3 Return history presented as price return in US$ Terms from before 2006. Returns from 2007 to present are on a Total Return basis.4 Relative performance shown as total return performance less performance of FTSE World total return index.

Please turn to the back cover for an explanation of Lehman Brothers' rating system.

Past performance is not a guarantee of future results.


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27 June 2008 7

GLOBAL INDEX TARGETS

Global Index Forecasts

Dividend Price Return Total return Total returnCurrent** End 2008 Yield Local Local $ terms

US 1322 1630 1.0% 23% 24% 24%Europe ex UK 355 425 1.5% 20% 21% 17%Japan 1346 1713 0.5% 27% 28% 42%UK 5666 7300 1.5% 29% 30% 27%Asia ex Japan 363 536 1.0% 48% 49% 46%

Global 331 415 1.0% 26% 27% 27%

*S&P500, FTSE W Europe ex UK, Topix, FTSE100, FT SE W Asia Pacific ex Japan, FTSE W World

** As of 26-Jun-2008

Price Indices*

We think the hawkish stance of the ECB is likely toresult in underperformance of Continental Europerelative to the UK.

We have reduced our targets for Europe, but still seesignificant upside potential for Continental Europe. Wethink the UK offers better prospects in several sectors.

Though there are concerns about the effect on equitiesfrom tightening policy, real interest rates remain lowglobally and are still below levels at which higher rateshave historically affected equities negatively.

Valuations are as attractive as they have been in 30years and the rate of earnings downgrades has sloweddown, both of which should lead markets to rally, in our opinion.

Net issuance from the corporate sector is still at lowlevels which is supportive for equities.

Investors have been selling equities in unprecedentedquantities, while the corporate sector has been retiring asimilarly large amount of stock. A large proportion of this capital seems to have flowed into money marketfunds and the high levels of cash holdings should be

bullish for equities.Source: Lehman Brothers research

Earnings Growth Forecasts

% % %

US 16 3 -5UK 9 2 -10Europe ex UK 15 8 0Japan 14 15 10Asia ex Japan 12 21 16

Global 14 7 0

20072006 2008

We expect earnings growth to decline by 5% in the US.

We expect earnings growth in Continental Europe to beflat this year, impacted by slowing top lines and risingcost pressures.

We expect earnings growth in Asia to be strong at 16%. In Japan, too, despite slow nominal growth, we believe

earnings growth ought to exceed that in Europe and theUS.

Source: Worldscope, Lehman Brothers research


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27 June 2008 8

RECOMMENDED WEIGHTINGS

Recommended Asset Allocation

BenchmarkRecommended

Weighting Recommendation

Equities 60 72 OverweightBonds 35 24 UnderweightCash 5 4 Underweight

The subprime crisis and resulting credit crunch have

injected a high level of volatility into the markets,compounding late-cycle effects. Over a 12-monthhorizon, we expect equity markets to recover and tooutperform bonds, supported by the combined effects of what we perceive to be attractive valuations andaggressive policy actions from central banks

Source: Lehman Brothers research and FTSE World.

Recommended Market Allocation


Wei gh ti ng R ecom men da ti on

North America 47 52 Overweight

Europe Ex-UK 21 12 Underweight

UK 9 7 Underweight

Japan 9 14 Overweight

Asia Ex-Japan 9 12 Overweight

Latin America / Other EMG 4 1 Underweight

We have moved to an underweight stance on

Continental European stocks and increased our exposure to the US.

We think the hawkish stance of the ECB is likely toresult in underperformance of Continental Europe.

Labour costs in Continental Europe are increasing faster than in the US, while earnings revisions and valuationsare moving in favour of the US.

We recommend overweighting Asian and Japanesestocks. These markets should enjoy better earningsgrowth and benefit from Fed easing, in our view.

Benchmark: FTSE W World Index.Source: Lehman Brothers research and FTSE World.

Recommended Global Sector Allocation


Wei gh ti ng Reco mm en da ti on

Basic Industries 9 0 Underweight

Capital Goods 10 6 Underweight

Consumer Cyclicals 10 13 Overweight

Energy 11 13 Neutral

Financials 21 31 Overweight

Banks 11 16 Overweight

Insurance 5 9 Overweight

Other 5 6 Overweight

Consumer Staples 8 0 Underweight

Healthcare 8 8 Neutral

Utilities 5 0 Underweight

Technology 10 17 Overweight

Telecoms 5 6 Overweight

Media 2 5 Overweight

We believe that the market will reward companies andsectors that are able to increase earnings in thischallenging profits environment.

We advocate an overweight position in Global Techand to a lesser extent in Telecoms.

We think Financials are oversold and should benefitfrom a steeper yield curve.

We have increased our weighting in the Consumer Cyclicals sector where earnings revisions have movedsharply negative.

We think Consumer Staples and Utilities areexpensive defensives and are underweight these.

We are also underweight cyclical businesses where wethink current valuations pay insufficient attention to the

prospects of slower economic growth: Capital Goodsand Materials.

We are neutral on Energy as the sector is attractively priced but without the growth of some sectors.

Benchmark: FTSE World Index. Source: Lehman Brothers research and FTSE World.


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27 June 2008 9

ONGOING STYLISTIC THEMES*

Emerging Market exposed basket rel to European Market

7677787980818283848586

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Index

We believe that European stocks with emerging marketexposure are likely to be re-rated relative to those withhigh exposure to the US market, based on increasingdivergence between growth prospects in the tworegions, as well as the formers reasonable valuations.

In our piece entitled Going for Growth in the EuropeanStrategy Weekly from 3 September 2007, we built

baskets of top-20 stocks that fall into both thesecategories.

The emerging-market-exposed basket has outperformedits US-exposed equivalent since September.

Chart shows the relative performance of a basket of emerging-market-exposed stocks relative to US-exposed stocks on an equal-weighted basis. Portfolioshave been rebalanced quarterly. Source: FTSE, Datastream, Lehman Brothers

For a full description of screening characteristics and hit ratios of the strategy, please refer to Going for Growth, European Strategy , 3 September 2007.Figures will reflect a rebalance as of 31 August 2007 based on the EuropeanStrategy piece Going for Growth.

Large Cap Versus Mid Cap

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Index

We believe that in an environment of declining earningsmomentum, large caps should outperform small caps.

Large-cap stocks are currently cheap relative to their history, while small-cap stocks are expensive.

Although the broader trend globally over recent years

has been toward small-cap outperformance, we have begun to see a turn in fortunes. Specifically, we haveseen large-cap stocks outperforming their smaller peerssince February of this year.

Chart shows the relative performance of highest/lowest quartile stocksscreened size on an equal-weighted basis. Source: Lehman Brothers, FTSE World, Worldscope, Exshare

Please click here for the latest daily update and more history on our website

For a full discussion of this investment theme, please refer to "Style Selector,16 August 2007

Composite Value

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Index

Although we have had a long-standing bias for growthstocks, we now believe there is a strong case for overweighting deep-value stocks in relation to growth.

Earnings revisions of value stocks have reached an all-time low relative to growth stocks.

Value has become synonymous with Financials, whichwe think are set to outperform.

Growth as a style can no longer be considered cheap.

Chart shows the relative performance of highest/lowest quartile stocksscreened on 12-month forward P/E, Dividend Yield, and Price to Book Valueon an equal weighted basis. Portfolios have been rebalanced quarterly. The

benchmark universe is the 500 largest stocks in the FTSE World index.Source: Lehman Brothers, FTSE World, IBES, Exshare


For a full discussion of this investment theme, please refer to "A Tactical Case

for Deep Value, Global Strategy , 14 April 2007.

* Themes referred to here are those that have been featured in recent Global Weekly Strategy reports, and where the advice is not captured in either the asset,regional or sector recommendations shown on the prior page.


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27 June 2008 10

GLOBAL PERFORMANCE

Global Market Performance 1 (%)

Regions 1 Week 1 Month 1 Year YTDUS -1.2 -3.5 -8.9 -8.4Europe ex UK -2.0 -7.2 -20.1 -16.5UK -1.6 -6.8 -10.9 -10.3Japan -4.7 -2.1 -22.2 -8.0Asia ex Japan -3.5 -8.8 -7.8 -17.5World -2.1 -5.0 -12.1 -10.5as of 25 Jun 2008

Global stock markets sold-off sharply amid continuedstagflation fears.

Japan gave back some of its recent strong performancethis week on concerns of weak economic growth athome and abroad.

The growth-sensitive Asian region was another notableweak performer.

The relatively defensive US market held up relativelywell compared to its global counterparts.

1 Performance is calculated on a local currency total return basis.Source: FTSE World, Lehman Brothers research Please click here for the latest daily update and more history on our website

Global Sector Performance 1 (%)

Sectors 1 Week 1 Month 1 Year YTDBasic Industries -3.0 -4.0 6.4 2.9Capital Goods -2.9 -5.9 -13.8 -12.2Consumer Cyclicals -2.7 -4.5 -18.7 -10.9Consumer Staples -1.7 -5.4 -3.8 -11.6Energy -1.8 -3.7 15.8 4.9Financials -3.0 -8.7 -30.0 -19.8of which: Banks -2.7 -10.1 -33.2 -21.0

Insurance -3.1 -6.6 -22.8 -17.2Healthcare 1.0 -1.1 -11.5 -10.7Technology -1.5 -2.1 -4.7 -9.0Media -2.4 -7.2 -18.9 -8.3Telecoms -1.3 -6.7 -9.2 -17.3Utilities -1.2 -1.4 0.5 -7.5Market -2.1 -5.0 -12.1 -10.5as of 25 Jun 2008

Defensives outperformed cyclicals across the board, asinvestors worries broadened-out beyond the financialsector.

Basic Industries, led by the Miners, underperformed onthe back of a flare-up in global growth concerns.

Financials were the other notable underperformer,weighed down on credit quality and inflation concerns.

Healthcare was the lone bright spot on the week asinvestors showed renewed interest in what had been previously regarded as an unattractive sector.

1 Performance is calculated on a local currency total return basis.Benchmark: FTSE W World Index.Source: FTSE World, Lehman Brothers research

Please click here for the latest daily update and more history on our website.

Global Style Performance 1 (%)

Styles 1 Week 1 Month 1 Year YTDValue (Cheap / Expensive) -1.3 -5.0 -26.0 -9.1Dividend Yield (High / Low) 0.2 -6.3 -16.9 -11.9FCF Yield (High / Low) 1.4 -2.3 -7.9 -6.6PE (Cheap / Expensive) -1.1 -6.0 -15.2 -3.7FCF Dividend Cover (High/Low) 0.7 1.9 -2.6 -1.6Profitability (High / Low) 1.0 0.6 15.4 5.6Cash Return (High / Low) 1.8 0.6 5.8 -2.8Risk (High / Low) -1.9 -2.5 -0.1 3.1Gearing (High / Low) 0.5 -1.3 -10.8 -8.3Size (Large / Small) 1.6 3.4 15.8 3.5Earnings Momentum (High / Low) 0.5 3.4 15.3 4.3Long Term f'cast Growth (High / Low) 0.7 4.3 12.4 7.5Internal Growth (High/Low) 0.3 2.3 18.3 9.8Composite Growth (High/Low) 0.5 3.8 20.1 8.9as of 25 Jun 2008

Value, led by the P/E style, underperformed.

Large caps outperformed their small cap counterpartsas growth fears heated up.

The High Cash return style was another notable strong performer.

1 Performance is calculated on a local currency total return basis.Benchmark: FTSE W World Index Source: FTSE World, Lehman Brothers research



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GLOBAL VALUATION AND PROFITABILITY

12 month Forward PE

Current ValuesUS Eur ex UK UK Japan Asia ex Jp

3World

Basic Industries 14.7 10.8 10.2 12.8 11.0 11.5Capital Goods 12.7 11.7 11.5 13.4 14.8 12.6Consumer Cyclicals 16.2 9.9 10.1 13.5 12.4 13.0Consumer Staples 15.3 14.1 13.8 21.8 14.5 15.0Energy 10.2 8.8 9.2 13.6 17.6 10.0Financials 2 11.7 7.7 7.4 14.5 11.5 9.7of which: Banks 10.9 7.8 7.3 13.3 10.6 9.0

Insurance 9.6 6.9 6.6 27.7 11.4 8.5Healthcare 13.0 13.3 10.9 19.4 20.9 13.0Technology 16.3 12.2 11.8 20.4 15.8 15.3Media 15.2 9.9 10.1 17.7 13.2 13.1Telecoms 12.5 10.5 10.3 12.4 14.7 11.8Utilities 15.4 13.9 12.6 44.7 18.1 15.3Market 13.3 10.1 9.8 15.0 12.7 11.9

Post 1990 Average US 1 Eur ex UK 6 UK6 Japan Asia ex Jp 3 WorldBasic Industries 15.6 13.0 12.4 58.5 12.8 15.2Capital Goods 16.2 16.1 11.9 31.7 17.0 17.5Consumer Cyclicals 16.1 15.4 12.7 30.7 13.3 16.4Consumer Staples 19.3 17.4 12.8 33.0 16.2 17.8Energy 16.0 14.7 15.1 31.9 15.0 15.8Financials 2 12.5 13.8 12.5 43.9 12.6 16.0of which: Banks 11.6 12.1 11.1 49.8 12.4 15.8

Insurance 13.7 17.9 16.4 37.3 12.8 16.0Healthcare 19.3 19.2 18.4 26.2 20.8 19.8Technology 22.7 22.8 19.4 89.2 3.7 23.7Media 28.2 19.2 19.8 24.0 18.5 24.3Telecoms 17.4 21.3 17.1 40.4 17.3 17.2Utilities 13.1 15.1 10.0 31.0 13.3 14.3Market 16.8 14.9 13.1 35.1 14.1 17.2

Enterprise Value / Sales


3World

Basic Industries 2.0 1.3 3.4 0.9 3.2 1.8Capital Goods 2.0 1.1 1.1 1.0 1.9 1.3Consumer Cyclicals 1.0 1.0 1.0 0.9 1.6 1.0Consumer Staples 1.6 1.3 1.7 0.8 1.2 1.4Energy 1.6 1.0 0.9 0.4 5.4 1.2Financials 2 NA NA NA NA NA NAof which: Banks NA NA NA NA NA NA

Insurance NA NA NA NA NA NAHealthcare 2.1 2.2 2.9 1.2 3.5 2.1Technology 2.8 1.2 1.3 0.9 1.1 1.8Media 2.3 1.3 1.7 0.6 3.4 1.8Telecoms 2.0 1.9 2.3 1.2 3.8 2.1Utilities 2.4 1.9 1.9 2.1 4.6 2.1Market ex Financials 1.7 1.3 1.5 0.9 2.5 1.5

Post 1990 AverageUS Eur ex UK UK Japan Asia ex Jp

3World


Insurance NA NA NA NA NA NAHealthcare 2.8 3.2 3.8 1.9 1.6 2.9Technology 2.7 2.1 1.7 0.9 2.2 1.9Media 2.6 1.8 2.3 1.1 3.3 2.1Telecoms 2.5 2.6 2.7 2.0 5.6 2.5Utilities 2.1 1.9 1.7 2.6 4.7 2.1Market ex Financials 1.8 1.1 1.4 0.9 2.5 1.4

Enterprise Value / EBITDA


3World


Insurance NA NA NA NA NA NAHealthcare 10.8 8.1 7.6 6.8 15.7 9.4Technology 12.5 6.9 9.3 7.4 10.1 10.0

Media 7.4 5.6 7.8 5.7 10.2 7.1Telecoms 5.9 5.1 6.3 4.1 7.9 5.7Utilities 8.4 8.2 7.1 8.4 11.6 8.2Market ex Financials 9.3 6.6 7.1 7.0 10.3 7.9

Post 1990 AverageUS Eur ex UK UK Japan Asia ex Jp

3World


Insurance NA NA NA NA NA NAHealthcare 13.8 11.9 12.7 10.3 12.7 13.0Technology 13.3 12.8 11.8 9.5 11.2 12.1

Media 11.1 8.4 10.8 7.5 14.0 10.0Telecoms 7.5 5.6 6.9 7.3 11.2 6.9Utilities 7.4 7.1 6.4 11.1 11.1 8.0Market ex Financials 10.0 6.9 7.8 10.0 8.8 8.9

1 Ratios reflect Earnings Before Goodwill Amortization,2 Financials excluding Real Estate3 Asia ex Japan = Australia, Hong Kong, New Zealand and SingaporeSource: Worldscope, Factset, IBES, FTSE, Lehman Brothers.


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27 June 2008 12

Return on Capital Employed 4 (ROE 4 Financials)

Current ValuesUS 1 Eur ex UK 4 UK4 Ja pan As ia ex Jp World

5

Basic Industries 12.7 12.2 20.3 8.1 22.0 13.3Capital Goods 9.6 11.3 13.5 7.2 9.8 9.4Consumer Cyclicals 5.8 7.5 11.3 6.2 10.9 7.2Consumer Staples 15.1 12.2 13.1 6.1 10.9 12.7Energy 19.6 20.1 20.7 6.7 19.4 19.0Financials 1,2 11.0 15.5 17.7 8.9 15.9 13.9of which: Banks 2 11.2 15.4 18.3 12.6 18.8 14.9

Insurance 2 13.7 19.4 16.5 9.4 24.3 16.3Healthcare 17.1 14.8 27.5 10.1 16.5 16.4Technology 17.5 15.2 11.8 5.6 11.6 13.5Media 7.7 14.2 12.4 5.2 8.4 9.0Telecoms 6.8 11.8 8.5 9.0 15.4 10.8Utilities 8.6 9.6 12.8 3.3 9.9 8.1Market ex Financials 11.6 11.4 15.8 6.5 13.6 11.1

Post 1990 AverageUS 1 Eur ex UK 6 UK6 Japan Asia ex Jp World

Basic Industries 9.1 9.1 11.2 4.1 11.1 8.0Capital Goods 9.0 8.1 9.7 3.8 7.6 6.9Consumer Cyclicals 8.3 6.7 9.2 4.2 9.2 6.5Consumer Staples 15.8 11.8 12.3 5.1 9.8 12.1Energy 12.2 12.1 12.1 4.0 12.8 11.4Financials 1,2 16.4 10.0 12.6 1.2 10.7 10.7of which: Banks 2 16.2 9.7 15.7 -2.7 14.7 10.4


Enterprise Value / Capital Employed (P/BV Financials)

Current ValuesUS 1 Eur ex UK 4 UK4 Ja pan As ia ex Jp World

5



Post 1990 AverageUS Eur ex UK UK Japan Asia ex Jp World



Free Cash Flow Yield

Current ValuesUS Eur ex UK UK Japan Asia ex Jp World

Basic Industries 3.6 4.7 4.1 3.0 2.8 3.5Capital Goods 7.5 2.9 8.2 3.1 4.6 4.9Consumer Cyclicals 4.2 4.6 5.3 0.9 4.4 3.5Consumer Staples 4.2 4.1 3.8 4.1 -0.5 3.9Energy 3.8 5.5 3.6 4.1 1.4 3.6Financials 1 NA NA NA NA NA NAof which: Banks NA NA NA NA NA NA

Insurance NA NA NA NA NA NAHealthcare 6.1 5.9 7.9 4.2 1.9 6.1Technology 4.6 6.9 7.2 4.5 1.6 4.5Media 5.9 13.9 7.8 3.3 5.1 6.9Telecoms 8.0 12.9 8.1 8.5 4.3 8.6Utilities -1.0 3.6 5.3 10.4 4.4 2.8Market ex Financials 4.7 5.4 4.9 3.5 3.3 4.5

Post 1990 AverageUS Eur ex UK UK Japan Asia ex Jp World

Basic Industries 4.2 4.4 4.0 0.3 2.5 3.1Capital Goods 5.1 2.6 4.9 -0.3 2.8 3.0Consumer Cyclicals 2.3 -0.1 1.7 -1.0 0.8 0.7Consumer Staples 3.6 3.4 3.8 1.3 3.1 3.3Energy 4.4 4.7 2.9 0.4 3.1 3.9Financials 1 NA NA NA NA NA NAof which: Banks NA NA NA NA NA NA

Insurance NA NA NA NA NA NAHealthcare 3.5 2.8 4.5 2.8 3.7 3.5Technology 2.9 2.2 5.4 -0.2 2.0 2.2Media 3.6 5.2 4.1 2.6 0.5 3.4Telecoms 4.9 3.3 4.0 3.3 3.6 5.1Utilities 3.7 4.5 2.2 -4.5 3.0 1.0Market ex Financials 3.6 3.0 3.3 -0.3 3.5 2.7

1 Financials excluding Real Estate,2 Return on Equity used for Financials,3 Price to Book Value used for Financials;4 ROE and RoCE calculated pre goodwill and pre exceptionalsSource: Worldscope, Factset, FTSE, Lehman Brothers.


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RESEARCH LIBRARY

Details of our regular research products are listed below.

Asset Selector Bond Yield Back-up Bullish for Stocks 30 th May 2008

Discerning Earnings 25 th April 2008

An Unprecedented Exit from Equities 4 th April 2008

Recessions, Earnings and the Market 28 th March 2008

Stocks, Bonds and Commodities A Single-Sector Perspective 21 st March 2008

Policy Should Provide a Panacea 18 th March 2008

Stocks have Decoupled from Credit 15 th February 2008

Trendy Valuations 1 st February 2008

Market Selector

US Versus Europe: The Valuation Debate 13 th June 2008

Downgrading Continental European Equities 6 th June 2008

Is Issuance an Issue? 23 May 2008

Japanese Judgement 9 th May 2008

Equities and an End to Easing 2 nd May 2008

Can Japan De-Couple? 14 th March 2008

US Recession Reality? 7 th March 2008

Sector Selector

Sectors across the Pond 13 th June 2008

Global Tech Stocks: Powering Up? 6 th June 2008

Not All Commodity Stocks Are Equal 16 th May 2008

Hong Kong Property: On Solid Ground 18 th April 2008

US General Retailers Are On Sale 28 th March 2008

US and European Banks 8 th February 2008

Style Selector

Languishing Leverage Factor 20 th June 2008

A Tactical Case for Deep Value 11 th April 2008

Style Rotation 29 th February 2008

Staying with the Large Caps 22 nd February 2008

Large Cap Growth Does Exist 11 th January 2008

Styles, Sectors and Regions for 2008 4 th January 2008

Stock Selector

When Disagreement is Good 25 th April 2008

Quality Companies for the Coming Quarter 18 th April 2008

Update of Growth Stock Selection Model 4 th April 2008What Happens When Dividend Yield>P/E? 29 th February 2008

Quantitative Selection of Growth Stocks 18 th January 2008

Quality Companies for the Coming Quarter 18 th January 2008

Quality Candidates for the Earnings Season 22 nd October 2007

Fund Flow Research

Retail Starts to Return 11 th April 2008

Buybacks Say More than M&A 14 th December 2007

Comfort in Money Market Funds? 26 th November 2007

Buybacks Continue in Strength 26 th November 2007

A Postscript on the Flows 24 th September 2007

Figuring Out the Flows 27th

August 2007Global Fund Flow Report Q1 2007 5 th March 2007


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27 June 2008 14


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27 June 2008 15

Analyst Certification:I, Ian Scott, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about anyor all of the subject securities or issuers referred to in this report and (2) no part of my compensation was, is or will be directlyor indirectly related to the specific recommendations or views contained in this report.

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Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2- Equal weight or 3-Underweight (see definitions below) relative to other companies covered by the analyst or a team of analysts that are deemedto be in the same industry sector (the sector coverage universe).

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Stock Rating

1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universeover a 12-month investment horizon.2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverageuniverse over a 12-month investment horizon.3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universeover a 12-month investment horizon.RS-Rating Suspended - The rating and target price have been suspended temporarily to comply with applicable regulationsand/or firm policies in certain circumstances including when Lehman Brothers is acting in an advisory capacity on a merger or strategic transaction involving the company.

Sector View

1-Positive - sector coverage universe fundamentals are improving.2-Neutral - sector coverage universe fundamentals are steady, neither improving nor deteriorating.

3-Negative - sector coverage universe fundamentals are deteriorating.Distribution of Ratings:

Lehman Brothers Equity Research has 2071 companies under coverage.46% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as Buyrating, 33% of companies with this rating are investment banking clients of the Firm.38% have been assigned a 2-Equal weight rating which, for purposes of mandatory regulatory disclosures, is classified asHold rating, 29% of companies with this rating are investment banking clients of the Firm.12% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as Sellrating, 21% of companies with this rating are investment banking clients of the Firm.


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27 June 2008 16

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stagflation versus valuation

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