The asset management teams of Allianz bring individual focus, methods, disciplines and independent thought to the investment strategy offerings of Allianz Global Investors. Their individual perspectives and methods lead to different outlooks and conclusions. At Allianz Global Investors, we value and encourage these differences and believe they lead to better and more responsive investment services for our clients. We hope you recognize this value as you review the following roundtable discussion among the chief investment officers from our five U.S.-based equity teams. We asked them to share their insights on capital markets in the closing days of the first quarter.

Our panel included: Peter Anderson, RCM Capital Management; Bill Bannick, Cadence Capital Management; Ben Fischer, NFJ Investment Group; Colin Glinsman, Oppenheimer Capital; and Horacio Valeiras, Nicholas-Applegate Capital Management.

Q: What is your outlook for equities in 2007?

Colin Glinsman, Oppenheimer Capital: We estimate the market can achieve double-digit gains in a stabilizing economic environment. We believe U.S. economic expansion will moderate and then continue growing at a modest pace for several years. Although the risk of recession has increased, we believe a simple mid-cycle slowdown is more likely.

Horacio Valeiras, Nicholas-Applegate Capital Management: We expect the U.S. market to be flat to up a few percent, nothing dramatic. The S&P 500, including dividends, will be up 3% for the year.  We think non-U.S. developed markets have an edge right now, and we expect a 7% to 8% EAFE return in local currency terms.

Bill Bannick, Cadence Capital Management: I think we’re going to have a positive year. With a P/E between 14 and 15 times forward earnings, the S&P 500 looks cheap relative to bonds. My first approximation for total return would combine beginning yield and growth. So let’s say we have a 2% yield and maybe a 5% to 6% nominal growth rate; with that, you could see an 8% total return without P/E expansion or contraction.

Ben Fischer, NFJ Investment Group: I think the direction should be up for the various indexes with both foreign and U.S. stock markets generally marching in the same direction.

Peter Anderson, RCM Capital Management: I think the most likely outcome would be high single-digit returns on the S&P 500, let’s say 5% to 10%. If there is a surprise, I think it’s a stronger market than we anticipate, not weaker. The economy is sufficiently strong, the interest rate environment is sufficiently strong and profitability is sufficiently strong, to produce a far better market than most expect.

Q: Does the downturn in mortgage equity withdrawals take the consumer out of the picture somewhat and does it foreshadow problems for the mortgage market?

Colin Glinsman: The growth of consumer spending will slow. Credit defaults and foreclosures will increase toward more normal levels even though the overall financial position of consumers will remain healthy. The consumer has been beyond healthy. Even a modest correction leaves the consumer okay.

Peter Anderson: We have strong employment numbers. We have strong wage numbers, which of course is a concern because if that gets out of hand relative to productivity it’s inflationary. But these are enormous props to the market. There’s no question a certain group of people have been financing their consumption by withdrawing equity from their houses, but equity withdrawal is not going to simply vanish because house prices stop going up. There’s still an enormous built-up accumulation of equity within homes that can be tapped.

Horacio Valeiras: Mortgage equity withdrawals have collapsed which is why economic growth in the U.S. will be quite a bit lower this year. The loan-to-value ratio for the country is still under 50 percent, so it’s not to the point where people are going to have to sell their houses to pay off home-equity lines. And interest rates aren’t going up. At the margin, the consumer is being slowed down, and I don’t think capital expenditures will jump in to replace the consumer. You’d need a lot of cap-ex to do that.

Q: Ben, can business spending make up the gap?

Ben Fischer: If you look at the top 500 companies-their liquidity, their cash on the balance sheet-is huge. I’m not sure if it’s going to be in any one short period of time, but I think over time, capital spending will increase.

Q: Which sectors and industries does this environment favor?

Peter Anderson: On a relative basis, the technology sector would be negatively impacted because part of the capital spending slowdown is technology related.  However, it’s important to remember many of these companies have large international components and non-U.S. markets remain robust.

Bill Bannick:  We’re finding attractive information technology companies, especially those tied closely to communications. I’m talking about Corning, Cisco Systems, Apple, Hewlett Packard, Sun Microsystems, IBM and so on. We own those stocks today because of their performance compared to their underlying earnings estimates and their valuations.

Q: Colin, which market sectors do you find most compelling at this time?

Colin Glinsman: Assuming the economy is in a mid-cycle slowdown, everything looks relatively attractive. There are particularly interesting opportunities in the consumer discretionary, energy, technology and industrials sectors. If we have a recession, a lot of those sectors are exactly where you shouldn’t be. In that case, attractive sectors include health care, where we’re overweight in our large-cap value and core portfolios, and consumer staples, where we’re generally underweight.

Q: Do you think stock multiples will expand?

Peter Anderson: Absolutely. I feel good about market valuations. The S&P 500 is selling at about 14 times forward earnings.  Given that multiples are to a significant degree determined by interest rates, current low interest rates would support a somewhat higher P/E number.

Colin Glinsman: The market is undervalued; it probably should be valued closer to 20 times operating earnings. If it turns out earnings have peaked, the market may already be fully valued. But to the extent we’re correct that the economy is in a mid-cycle slowdown and earnings won’t peak until about 2010, the market is undervalued and should continue to provide good returns.

Ben Fischer: I don’t think stock multiples are going to expand dramatically in 2007, or in years shortly after. That should be good for value investors versus growth because you’re going to need more of your return to come up front in yields.

Bill Bannick: I think they will expand. I don’t see them going to 20 but I could see a small move. My call for higher-than-expected returns this year is based on a little bit better earnings than expected and a slight expansion of P/Es.

Horacio Valeiras: I think multiples for growth stocks will expand, but will contract for value stocks.  When growth is harder to come by, investors favor companies that can deliver cash flow. These tend to be the stable growers and they do well.

Q: Is this a growth environment or a value environment?

Peter Anderson: Well, of course, you have to understand the prejudices that we have in this shop. We’re a core-to-growth manager.  Last year the Russell 1000 Value Index outperformed growth by 1,300 basis points. That gap was the widest it has been since Russell began tracking these style statistics. The extremes are so great that valuation differences between value stocks and growth stocks have almost vanished. I think that is not a sustainable proposition and I think valuation and price performance both argue for growth outperforming value as we move forward.

   
Ben Fischer: Well, I don’t think there’s any argument that can be made in favor of either growth or value.  With value, you get a yield argument. With growth you have expansion of capital spending. I think both styles are on relatively equal footing.

Bill Bannick:  The definition of growth today argues for continued value leadership. Please let me explain. The way the Russell organization builds growth benchmarks, and I’m going to be overly simplistic, is they take stocks with a combination of high forecasted growth rates and also high valuations. The growth benchmarks tend to be full of high-expectation, high-valuation companies and generally that combination is not a good bet, because it rarely works. My preference is for a classic growth style, meaning stable-growing companies that are not especially economically sensitive. Back in the 80’s and early 90’s growth stocks were companies with relatively consistent revenue and earnings growth histories and expectations.

Q: What about small versus large?

Horacio Valeiras: We expect large to outperform. Small companies tend to be more economically sensitive and their valuations are high relative to large.

Bill Bannick: It seems lately that whenever I go to an investment meeting or conference, someone asks: "When are large caps going to take back the lead?" or "When will small caps fall off their leadership perch?" It hasn’t happened. I think what it takes for small caps to be bad stocks is we have to have a negative market because they tend to be the higher beta stocks and they tend to lead the markets down.

Ben Fischer: I agree. I think it’s the economy that really counts. If you have a good growth rate in the economy worldwide, then you’re fine. If you have a slowdown or a recession, then you’ve definitely got to be in large cap and growth. Until I see a recession, I’m not going to make that call.

Q: There’s a lot of talk right now about whether the economy will achieve a soft landing, a hard landing or fall into recession. What do you expect?

Bill Bannick: I say no recession and I expect a soft landing, with positive real GDP growth on the order of 1.5% to 2.5%. I don’t see a barnburner year but I don’t see a recession either, absent some true spreading of underlying problems in the mortgage markets. Maybe there’s a 5 to 10% chance of recession.

Ben Fischer: We view the economy as stronger than people think because it’s driven by worldwide events. It’s China and India and other countries. I don’t think we can depend on looking at the housing market within the U.S. to predict what’s going to happen in a global economy. From that point of view, I’d say that the economy’s pretty healthy, it might not grow quite as fast because the U.S. is having a slowdown in one area of the economy, but I don’t see any real risk of recession.

Q: What’s your long-term view?

Ben Fischer: We have this tendency in financial markets to look back over the last 30 years and apply regression analysis and project forward into the future. I think that’s totally useless right now because we have millions of people coming into the market economy in China and India. If you look at commodities, we’re going to have shortages of energy longer term, shortages of metal, shortages of corn. There are just too many people in China who want to drive a car and they’re going to need new roads, new electric power generation and fuel sources. It’s a huge secular trend. You can’t just go back and say, well, we’re going to have a recession and the price of oil is going back to 25 because it always did. I don’t think that’s going to happen.

Colin Glinsman: Regardless of how the market performs in 2007, our research indicates we’re in the middle of a prolonged advance, particularly given that the stock market has flourished following the last two mid-cycle economic slowdowns in 1984 and 1995. The market can go higher because earnings will grow during the second part of the expansion and multiples will stay put or increase until quite late in the cycle, likely 2009 or 2010.