Ben Fischer 

NFJ Investment Group

Outlook

We believe October 2008 through March 2009 will mark the worst stretch of the stock market decline. Investor sentiment has been very pessimistic but the basic, underlying foundations of most of the S&P 500 companies are in good shape, in our opinion. If they're non-financial companies, they generally have cash and cash flow but their valuations reflect extremely low expectations for the companies and the economy. When sentiment gets this extreme and the market is down and showing signs of bottoming, we begin anticipating upside.

We believe there's a good chance of a significant market rebound in 2009. It may well be a W-shaped recovery. Or it could be what we call a bathtub rally, where the market goes down one side and it wallows around for a long time, and then it finally comes up on the other side.

The characteristics of economic recovery will likely be determined by the results of a race against the country's credit problems. If policymakers can create enough liquidity, then the economy may bottom sometime late in 2009 and we'll have growth in 2010, although it may be at a sub-par level.

We expect little to no growth in Gross Domestic Product in 2009 and GDP growth of 1% or more in 2010. Amid the continuing credit problems, we expect the Federal Reserve to continue to do what it needs to do to restore liquidity and it has a lot of creative choices in terms of getting the money supply moving.

We believe the risks to the economic recovery are mainly financial. If credit remains constricted and money velocity remains low, with people just sitting on cash and not spending, then we would expect the recovery to be slow. The economic turnaround depends heavily on the government's planned fiscal stimulus measures, how swiftly they are deployed and how they are targeted to create growth.

Particulars

• We are positioning our portfolios to take advantage of opportunities where we see fundamental strengths. We are fully invested, so we don't have very much cash. At the margin, we are moving away from defensive stocks and more into early cycle stocks. These are small moves not large allocation changes. We remain underweight financials and overweight industrials and energy.
• We remain positive on international investing. Despite recent, steep declines for international markets, in the longer term they remain attractive to us. We don't see any road block to that outlook, unless the world economy doesn't recover at all. In our view, growing and developing countries like China or India will stimulate their economies and restore growth, which would bode well for natural resource stocks over the longer term.
• At some point we expect commodity prices, including energy to start rising and to reflect economic growth in the more basic areas. Commodity prices were hit hard last year but are expected to recover. At the current price of around $38 a barrel, we believe oil prices are too low. We anticipate Saudi Arabian oil producers will push prices to $75 to $80 at some point this year, creating investment opportunities in energy. A rebound in commodity prices will help companies in the industrials sector as well as in energy.
• We see opportunities among those industrial companies with significant cash flow. There are plenty of high quality companies - large and small - that are living within their balance sheets. These companies are not borrowing money. They're using cash flow. While there has been a tremendous decline in capital spending, these companies are financing their capital spending internally.
• We would expect companies in the utilities and consumer staples sectors to lag an overall market recovery.

Opportunities and Threats

• Historically, value stocks have outperformed when economic recovery begins. However, it remains uncertain how the current economic situation will stack up versus previous recoveries. It's certainly not comparable to any period except the Great Depression. We are not prepared to forecast how soon and how fast we emerge from recession. Growth stocks tend to do well going into a recession. At the beginning of a recovery, value stocks, led early by cyclicals, like banks, financials, and housing-related companies, typically perform better.
• We expect small capitalization companies to perform better than larger caps in the recovery. Small caps are typically more sensitive to economic changes. If the dollar is weak, smaller companies, which are mainly domestic producers with a lot of sales overseas, may do well since their costs are in dollars and they sell their products in other currencies. · Over the longer term, we expect inflation to become a factor, which would require investors to extend their risk exposure.
• The economic recovery depends on how fast the government gets stimulus money to work. If the government dedicates a large part of those funds to infrastructure, then that's going to positively affect certain cycles and certain sectors. If the government runs into roadblocks and can't get money to work to stimulate growth, then we may be in for a slower economic recovery.
• Our advice to individual investors is to dollar cost-average and extend toward riskier types of investments moving forward. We believe the worst decision over the next two years will be holding U.S. Treasury securities, especially those with short maturities. While Treasuries are safe bets, since investors don't lose their principal, inflation will begin to factor in at some point in 2009 or 2010. Investors don't want to be in a zero-yield, risk-free rate of return mindset only to find out that they have embraced a return-free risk.