Baird, Riverfront Strategists Forecast 2010 Outlook at Baird Economic Event

Generational Shift Toward Saving, Increased Investing to Create New Secular Bull Market

Bruce Bittles, Chief Investment Strategist for Baird, and Rod Smyth, Chief Investment Strategist and Founding Partner for Riverfront Investment Group, offered their 2010 outlook as part of a Baird Market and Economic Outlook event held Thursday. The two experts discussed a generational shift toward saving and investing, the key markers of a recovery, and the continued impact of government legislation and policy on markets.

Baird is an employee-owned international wealth management, capital markets, asset management and private equity firm. For a video featuring additional insights from Bruce Bittles on the state of the economy and financial markets, please click here.

Shift toward saving essential to recovery
Unquestionably, the past 18 months have been one of the most dramatic periods in the history of the U.S. economy and financial markets. The good news, according to Bittles, is that it appears the economy has survived, and there are signs of economic improvement including a higher GDP and renewed activity in the manufacturing sector. We also are starting to see stability in the housing market, which is critical to restore the average investor’s confidence. While corporate profit margins have remained relatively strong, unemployment is expected to remain high.

“Fundamentally, we’re experiencing a generational shift from borrowing and spending toward a renewed focus on saving and investing, and a movement away from risk,” Bittles said. “It’s encouraging that consumers are beginning to pay down some of their debt. This increase in savings and investing will lay the foundation for a new secular bull market.”

Smyth added, “It is the paradox of thrift. While it is undoubtedly right for individuals to save in this environment – and there will not be sustainable growth without it – if everyone saves, no one spends. Policymakers are facing a difficult choice.”

Outlook for global markets, value of the U.S. dollar
The U.S. has not been alone in its challenges. “This was an unprecedented synchronized global decline,” Smyth said. “However, while our nation continues its slow journey toward recovery, other countries that aren’t as burdened with high debt are beginning to enjoy relative prosperity again. It’s expected the U.S. will lag behind the global economy in its recovery process and the dollar will remain weak.”

Debt anchor holds markets back
“The stock market continues to be the best leading indicator for an economist to have in his or her toolbox,” Bittles said, recalling that the market first began its rally in March at the depth of the recession. “That strongly suggested that the economy would begin to improve, and it did.”

The slow pace of growth is not surprising given the obstacles that remain. “The debt anchor acts as a burden to growth,” Bittles said. “It’s a delicate balance here. If we grow too quickly, that can lead to inflation and rising interest rates. If it’s too slow, deflation and a dormant economy that bounces in and out of a recession can result. The stock market actually does best in a slow growth economic environment.”

Long-term economic impact of Fed monetary policy
Overall, concerns remain about the sustainability and durability of the recovery, in large part due to the unprecedented level of government intervention. “As a nation, we’ve gone more into debt to get out of debt,” Smyth said. “Starting with the Lehman crisis last fall, the Federal Reserve’s balance sheet went from $800 billion to $2.2 trillion.”

The country will need to shoulder the burden of this debt and do so carefully. “While the government’s initial intent was to create enough liquidity to offset fear, all of it must be recovered in time, likely in the form of higher taxes, or it will lead to inflation,” Smyth said.

The purpose of recessions and lessons for investors
While painful, the financial challenges we have faced impart wisdom to investors and, ultimately, will put the U.S. economy on sturdier ground. “Recessions serve a purpose: they cleanse the system of the excesses of the past,” Bittles said.

Post recession, many investors are moving toward a more conservative approach. “Investors had more risk in their portfolios than they thought or wanted,” Bittles said. “In fact, surprisingly, 90% of the money that has come out of money market funds recently has gone into bond funds.”

However, Smyth cautions against playing it too safe. When making an investment, his first consideration is always price. When looking at Treasury bonds, for example, “the price of safety is very high, especially after inflation,” he said. “On the other hand, the price of taking on risk today is still fairly attractive.”

“In coming years, we’re going to see an increased use of alternative asset classes,” said Bittles, who suggests holding a small position of gold for some investors. “I think you’ll also see cash as an asset class gain some esteem.”

“Our recommendation is to focus on areas that benefit from a weak dollar,” Bittles said. “We like large and mid cap stocks versus small caps right now. Small caps outperform at the beginning of a recovery, but more established companies will do better as the recovery takes hold.”

Smyth agreed, encouraging investors to stick with higher quality stocks that are currently a good value. Smyth also suggested investors have some exposure to emerging markets, commodities, and high quality corporate bonds.

About Bruce Bittles and Rod Smyth
With more than 35 years of industry experience, Bruce Bittles has served as Baird’s Chief Investment Strategist since 2002, providing strategic economic and market analysis to the firm’s individual, institutional, and corporate clients. He writes market commentary for Baird and a frequent contributor to national media outlets. Prior to joining Baird, Bittles served as Partner in Charge of Market Strategy at J.C. Bradford & Co. from 1985 through 2000.

Rod Smyth is a Founding Partner and Chief Investment Strategist of Riverfront Investment Group. He is a native Irishman with 25 years of global investment experience. Smyth has lived and worked in the securities industry in Asia, Europe and North America. He started in Japan in 1983 and worked as an Asian specialist for Citicorp on Wall Street from 1985 -1988. In 1988, Smyth went home to Ireland where he worked for six years as a portfolio manager investing in the US, Asian and Latin American markets, returning to Japan in 1993 as the Investment Strategist for Baring Securities in Tokyo. He has been back in the U.S. since 1996, and is now Chief Investment Strategist for Riverfront Investment Group. Baird is a minority investor in Riverfront.

About Baird
Baird is an employee-owned, international wealth management, capital markets, private equity and asset management firm with offices in the United States, Europe and Asia. Established in 1919, Baird has more than 2,400 associates serving the needs of individual, corporate, institutional and municipal clients. Baird oversees and manages client assets of more than $66 billion. Committed to being a great place to work, Baird ranked number 14 on FORTUNE’s “100 Best Companies to Work For” in 2009 – its sixth consecutive year on the list. Baird’s principal operating subsidiaries are Robert W. Baird & Co. in the United States and Robert W. Baird Group Ltd. in Europe. Baird also has an operating subsidiary in Asia supporting Baird’s private equity operations. For more information, please visit Baird’s Web site at www.rwbaird.com.