2010 outlook

HAVE RFORDOutlOOk

J a n u a r y 2 0 1 0

2 0 0 9 : w h a t a d i f f e r e n c e a y e a r m a k e s 2

h a v e r f o r d 2 0 1 0 o u t l o o k

the economy, equities & fixed income 3

the economy: tailwinds vs headwinds 4

equities: cyclical to Predictable 6

fixed income: calm returns to the market 8

a b o u t h a v e r f o r d

haverford’s Quality Investment Products, clients & services 11

2 | h av e r f o r d 2 010 Outlook

2009: what a difference a year makes

what a difference a year makes

last year at this time, we wrote that despite the fear and panic, the aggressive actions of the federal reserve coupled with the start of fiscal stimulus spending would spark an economic recovery in the second half of 2009 after finally bottoming in early march, the equity and credit markets staged an impressive rally led by lower quality companies and below investment-grade securities, which is typical during the early stages of a recovery we expected the equity markets to strengthen in anticipation of this recovery, and be lead higher by economically sensitive sectors such as basic industry and industrials, at the expense of defensive sectors that held up relatively well in 2008 haverford made incremental shifts in our equity holdings throughout the year to take advantage of this trend after delivering the worst ten-year return in a century we believed that equity returns would revert to the mean — a theme in which we continue to believe we anticipated that short term fixed income rates would stay low throughout the year, the yield curve would steepen, and credit spreads would tighten as the economic recovery took hold accordingly, we overweighted corporate credit throughout the year

h av e r f o r d 2 010 Outlook | 3

haverford 2010 outlook

the economyPowerful tailwinds ensure the ��

economy will likely continue to expand throughout 2010

stubborn headwinds should keep the ��

expansion muted and below average

an oversold dollar may rebound in ��

2010, although the intermediate to longer-term trend is downward

due to excess capacity and high ��

unemployment, inflation should remain benign through 2010 and into 2011

monetary policy will likely remain ��

accommodative throughout 2010 even as the fed begins to start withdrawing its stimulus

Global GdP is in an upturn led by ��

developing economies, which we expect will have growth rates over twice that of developed economies

equitiesthe bull market in equities will ��

likely continue in 2010 but investors should expect a correction and some pull-backs

expect market leadership will shift ��

from low-quality to high-quality companies

in both our Quality Growth and ��

Quality dividend value portfolios we will continue to emphasize firms with global exposure, particularly to emerging economies whose growth rates are faster than developed economies

we anticipate reducing economic ��

exposure as we add to stable, highly predictable companies

valuations should remain attractive, ��

with higher quality stocks offering the most attractive risk/reward characteristics

fixed incomethe steep treasury yield curve ��

will flatten as the federal reserve begins to unwind its exceptionally simulative policy

yield spreads in other taxable ��

bond market sectors will likely be considerably less volatile than in the past two years

as a result of improved conditions ��

in the capital markets, we anticipate domestic corporate credit events will generally be contained and not result in system-wide contagion

there will likely be considerable ��

dispersion of performance between both domestic municipal credits and global sovereign borrowers

The opinions expressed herein are those of Haverford. No forecasts are guaranteed. Views and security holdings are subject to change at any time based on market and other conditions. This publication is for informational purposes only and should not be construed as investment advice or recommendations with respect to the information or specific securities presented. Past performance is no guarantee of future results.

Investments in securities are not FDIC insured, not guaranteed by any bank, and may lose value.© 2010 Haverford Trust Company, Inc., All Rights Reserved

4 | H av e r f o r d 2 010 Outlook

The economy: Tailwinds vs. Headwindsour outlook for United States Gross domestic Product growth in 2010 can best be characterized as a battle between multiple, stimulative tailwinds and formidable headwinds. Powered by the tailwinds of monetary stimulus, a global synchronized recovery, productivity gains, and fiscal stimulus, U.S. GdP growth turned positive in the third quarter of 2009. The economy will likely continue to expand throughout 2010, albeit at a below average rate, due to the headwinds of consumer deleveraging, the financial system deleveraging, and government regulatory intrusions.

of the tailwinds, monetary policy has the biggest impact on the U.S. economy. We have seen more monetary policy initiatives in the past 15 months than during any period in the past 70 years. Monetary policy should remain accommodative throughout 2010 even as the fed begins to start withdrawing its stimulus. The challenge the fed faces is balancing between tightening too soon, thereby potentially choking off a nascent recovery (as happened in the 1930’s), or remaining accommodative too long, thereby sowing the seeds for future inflation. as an institution, the fed has a strong anti-inflation bias which it learned from its mistakes in the 1970’s. But the current fed Chairman, Ben Bernanke, is also a student of the 1930’s, and he realizes how policy mistakes of that decade — one of which was the fed tightening too soon — made the depression worse.

fortunately due to excess capacity and high unemployment, inflation should remain benign through 2010 and into 2011. This gives the fed ample leeway to keep rates lower for a longer period of time. even as the fed begins to raise rates, which we expect by mid-year, monetary policy will remain very stimulative well into 2011.

aggressive monetary stimulus has occurred throughout the world, resulting in an unprecedented synchronized global recovery. Global GdP is in an upturn led by developing economies (China, India, Brazil, etc.), which we expect will have growth rates over twice that of developed economies (U.S., europe, etc.) in 2010. This synchronized upturn has a multiplier effect that is easy to underestimate — never before has the world experienced a uniform recovery of this breadth and magnitude. Unlike previous expansions, the U.S. does not have to carry the rest of the world on its shoulders.

Source: International Monetary Fund World Economic Outlook (October 2009), Haverford.

2.0%

0%

2%

2010 2011 2012 2013

Developed Economies Developing Economies

5.1%

6.1%

2.6%

6.4%

2.5%3%

4%

5%

6%

7%

1%

6.6%

2.5%

C H a n G e I n r e a l G d P

estimated annual % Change in real GdPGlobal GDP is in an

upturn led by

developing

economies, which

we expect will have

growth rates over

twice that of

developed

economies in 2010

and beyond.


Productivity gains, which are at the highest levels since the kennedy administration, are powering a recovery in corporate profits that have exceeded expectations it is a mistake to think cost cutting provides just a one-time benefit to the bottom line these productivity enhancements will have lasting benefits to corporate profits even when companies start rehiring more importantly, company profits can continue to grow in the face of a below-average expansion

the majority of the fiscal stimulus package, passed last february, remains to be spent throughout 2010 while we would have preferred a combination of more tax cuts and shovel-ready construction spending, the fiscal stimulus is still a positive factor, although much less than it could have been

historically, one of the most important determinants of the strength of an economic recovery is the severity of the recession that preceded it if that were the case this time, we would be experiencing a massive recovery, but significant and stubborn headwinds challenge the precedent the financial system’s restricted lending capacity is the most significant headwind facing our economy the banking system, for many reasons, is still not functioning properly, placing strains on both consumers and small and mid-sized businesses that are having difficulty accessing capital because consumer spending and services make up 70% of GdP, consumer deleveraging, which will take several years to play out, will temper growth during that time small and mid-size businesses are also reluctant to hire and plan for the future while the outcome of so many government initiatives (e g cap & trade, health care reform, financial reform, higher taxes) remain uncertain throughout 2010 we should gain more clarity on these issues, which will allow businesses to properly plan for the future

increasingly, the dollar, inflation, and deficits are cited as headwinds by negative prognosticators who believe the economic recovery is not sustainable deficit spending has been a necessary evil and most likely helped avert a depression essentially, public debt has been a substitute to private financing since the credit crisis began we believe that once the economic recovery is firmly in place washington will be forced to curtail these deficits, otherwise they will become a headwind to growth

despite the growth in the money supply, we believe inflation will remain muted thanks to tremendous excess capacity in the system and high unemployment we believe the rising price of gold is not a harbinger of inflation, but instead the result of a technical trade (“carry-trade”) related to the weakening dollar, akin to the 2007-2008 run-up in oil

60

80

90

100

110

120

130

140

150

‘73

Source: FactSet Research SystemsU.S. Dollar Index represents the nominal trade-weighted exchange rate for the U.S. Dollar against major trading partners(base exchange rate of 100 on January 1, 1997)

70

‘75 ‘77 ‘79 ‘81 ‘83 ‘85 ‘87 ‘89 ‘91 ‘93 ‘95 ‘97 ‘99 ‘01 ‘03 ‘05 ‘07 ‘09

Recessionary Periods

u s d o l l a r i n d e xDespite the

probability of near

term strength, the

dollar remains in a

long-term decline.


while the dollar’s 2009 decline is mostly a reversal of the “flight-to-safety” trade during the peak of the financial crisis, some of the dollar’s weakness relates to concerns that the fed’s zero percent interest rate policy will lead to much higher future inflation traders have taken advantage of these fears by borrowing the dollar in order to purchase foreign currency and hard assets, such as gold we expect the dollar will strengthen in 2010 as traders anticipate the fed raising interest rates a stronger dollar could also result from better than expected u s GdP growth

despite the probability of near term strength, the dollar remains in a long-term decline in fact, the dollar has been in a 40-year downtrend this is not due to a decline in the economic strength of the u s as some have suggested on the contrary, over the past 40 years, u s industrial output has increased with fewer workers generating greater productivity while the u s economy continues to grow, more and more global economies are beginning to flourish the dollar is no longer the only relevant currency as it was 40 years ago today there is more freedom around the globe, more free markets and capitalistic economies than at any time in world history investors should not lose sight of the fact that our domestic economy is a beneficiary of these global trends, even if the dollar weakens because of them

overall, we believe the tailwinds will prevail over the headwinds, resulting in positive GdP growth with minimal chance of the economy dipping back into recession we expect these headwinds will result in below average GdP growth of 2 5% - 3 0% we recognize that this is the consensus view, and given the monetary tailwinds and global strength of this recovery, we risk underestimating u s GdP growth

equities: cyclical to Predictablethe performance of the equity markets in 2009 has been contrary to the results of 2008: lower quality stocks have significantly outperformed and those stocks with the greatest price declines in 2008 have experienced the largest rebounds in stock price the flight toward lower quality is consistent with previous markets’ behavior at the tail end of a recession lower quality companies typically have more economic exposure and leveraged balance sheets their earnings and stock price often suffer the most during a recession consequently, investors flock to these companies in anticipation of significant earnings growth during the initial stages of the economic recovery if we are correct in our outlook for a muted economic expansion, the market should favor higher quality companies for several reasons: they have lower leverage, easier access to capital, significant cash reserves, more predictable earnings that are less impacted by the level of GdP growth, ability to grow their dividends, and the capacity to invest for market share gains through strategic acquisitions in fact, this trend has already begun to take hold and we expect it to continue throughout 2010

last year in anticipation of this recovery, we took profits in some of our very defensive companies such as Proctor & Gamble, wal-mart, Johnson & Johnson, abbott labs, and colgate, all of which held up well in 2008 incrementally, we purchased companies with more economic exposure such as air Products, du Pont, union Pacific, and caterpillar in our Quality Global strategy we added to the emerging market sector at the start of 2009, recognizing those economies would likely lead a global recovery this year we anticipate reducing some of our economic exposure as we add to stable, highly predictable companies whose earnings can grow regardless of a slow growth economy

in both our Quality Growth and Quality dividend value portfolios we will continue to emphasize companies with global exposure, particularly emerging economies whose growth rates are faster than developed economies currently 43% of portfolio revenues come from international sources, which we anticipate will rise in 2010 in our Quality Global strategy we plan to opportunistically add to emerging


markets that have risen approximately 100% off of their lows of the past year rather than chase this return, we will be patient and wait for a correction at some point in the new year

despite the s&P’s 60% rise off of the march low, investors remain cautious, anxious and fearful this is best exhibited by what investors are doing, not necessarily saying while expressing relief that the crisis has past, investors are still hording cash that earns little to no interest what investments they are making are going into bond funds — over $200 billion year-to-date 2009 saw no net inflows into equity funds and, remarkably, in the last two months of the year there were net outflows despite the markets’ advance investor skepticism is healthy for the markets we believe pullbacks and corrections will be used as opportunities by investors, who have thus far missed the upturn, to invest in stocks

even after this year’s market advance, stocks are attractively priced at 14 5x normalized earnings this is well below the historical average of 16 9x when you consider the low levels of interest rates and inflation, equity valuations appear cheap furthermore, higher quality stocks offer the most attractive valuations and risk reward characteristics

equity dividend yields are still particularly high compared to treasuries investors desirous of higher yields and willing to accept greater volatility should consider equities as an alternative to fixed income for example, haverford’s Quality dividend value portfolio currently yields more than 4%, twice that of the broad equity averages, and greater than the 10-year treasury’s yield

while we believe the bull market will continue in 2010, it is realistic to expect pullbacks and corrections however, we anticipate that by year-end stocks will be higher even if the economy slows, corporate profits will continue to lead the recovery as productivity drives margin expansion finally, we believe the equity markets will continue their reversion to the mean, and equity investors will be well rewarded over the next 5 to 10 years

s t o c k s r e t u r n s b y Q u a l i t y r a n k i n G a n d P e r i o d

-40%

-50%

-60%

-30%

-20%

-10%

0%

Source: Factset. Based on the S&P Earnings and Dividend Ranking System. Indices are market-cap weighted and include only stocks currently in the S&P 500. Performance is based upon static indices and does not account for S&P rating changes.

B

-37.7%

C/D/NR

-53.8%

S&P500

-37.0%

A

-28.3%

10%

0%

20%

30%

40%

50%

A

8.6%

B

24.2%

C/D/NR

40.3%

S&P500

19.3%

2%

0%

4%

5%

6%

7%

1%

3%

A

6.0%

C/D/NR

4.9%

S&P500

4.0%

B

2.6%

Full Year 2008 January ’09 – September ’09 October ’09 — November ’09

We expect the

rotation into

high-quality stocks

will continue

throughout 2010.


fixed income: calm returns to the market

the fixed income markets enter 2010 in an almost polar opposite position from the beginning of 2009 the events of 2008 culminated a two-year process of reassessing the correct price for risk and a resultant flight to quality after outperforming all other sectors during 2007 and 2008, u s treasury securities were the worst performing sector of the taxable bond market in 2009

the federal reserve has kept to its word and maintained short-term rates at extraordinarily low levels to stimulate both the economy and the markets anchored by 0% on the short end, the treasury yield curve has steepened during 2009 the 30-year yield is now 4 50%, up from 2 68% at the end of 2008 and extremely close to its average of 4 51% over the past four years the 10-year has risen from 2 21% to 3 58%, still below its recent average of 4 08% in contrast, the three-year yield has only increased from 0 97% to 1 36%, considerably below its four year average of 3 45% these longer term relationships are useful in gauging what we expect will happen as the fed begins to unwind its exceptionally accommodative monetary policy short rates reflect fed policy and will likely rise proportionately more so than long rates when the fed starts tightening while this may not happen until mid-year, the result will be a flatter yield curve this scenario will provide investors with an opportunity to add exposure to short and intermediate treasuries

there has been increasing speculation regarding the impact of a declining u s dollar on the international demand for u s treasury debt while these concerns are valid, the evidence contradicts the most pessimistic scenarios in fact, there has been record demand for treasuries in 2009, which absent any extreme event, we expect to continue in 2010

800

700

600

500

400

300

200

100

0

Basis Point Spread over Treasuries

1998 1966 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Barclays Capital

Agencies

BBB-Rated Corporates

AA-Rated Corporates

Mortgage-Banked Securities

y i e l d s P r e a d o v e r t r e a s u r i e sAfter two years of

extreme volatility,

non-Treasury

sectors should

remain within a

much narrower

trading range.


the federal reserve has used its balance sheet to purchase securities to help support markets, most notably agency mortgage-backed securities (mbs) to date, the fed has purchased in excess of $1 trillion agency mbs, which has helped keep mortgage rates low and provided much needed liquidity in that market these measures have helped restore the market for conventional securities, but not for structured and derivative securities the strength of the rebound in demand for both corporate bonds and mbs can be explained by the absence of the complicated structured securities that had received so much demand during 2006 and 2007

the strength in corporate bonds has been accompanied by a sharp increase in supply the market has absorbed $1 3 trillion of new issue corporate bonds during 2009 compared to $927 billion for 2008 the fed also used its balance sheet to support the corporate bond markets during 2008 at the peak of stress on the market, the fed held in excess of $300 billion in corporate commercial paper compared to current holdings of less than $25 billion clearly, corporate treasurers felt the pressure of being overly reliant on short-term debt and have extended maturities to avoid such pressures in the future we believe this process is substantially complete and will not impact supply during 2010 this will leave demand and supply closer to equilibrium and spreads within a much tighter range than the extreme volatility of the past two years

the recent crisis in dubai and Greece’s sovereign debt downgrade serves as a reminder that the markets remain volatile dubai and several sovereign issuers (Portugal, italy, ireland, Greece, spain, etc ) will likely pressure the sovereign debt markets and result in a considerable amount of dispersion in the performance of global sovereign credits we do not believe the market is correctly compensating investors for the risk inherent in the potential for these borrowers to ignite a crisis; therefore, we have no exposure to sovereign debt in balanced Quality Global portfolios

the municipal bond market also experienced a substantial recovery during 2009 lower yields were a result of the combination of overall market improvement and concerns over rising income tax rates similar to taxable markets, the municipal market has absorbed a substantial increase in supply new issuance during 2009 has been $367 billion, well above 2008’s $281 billion

50%

45%

40%

35%

30%

25%

15%

5%

0%

AL AK AZ CA CO CT DE FL GA HI IAID IL IN KS KY LA MAMDME MI MN MOMS NE NH NJ NM NCNY OH OK OR PA RI SC SD TN UT VAVT WA WI

State Budget Deficits as % of General FundsSource: www.ThePewCenterontheStates.org and www.BLS.gov

20%

10%

AR MT NV ND TX WV WY

16%

14%

12%

8%

4%

10%

6%

Budget Gap Unemployment

2 0 1 0 P r o J e c t e d s t a t e b u d G e t G a P s a n d c u r r e n t u n e m P l o y m e n t


state and local governments continued to experience severe financial strains historically, real estate and income taxes have been the largest sources of revenue for local governments the combination of the severe housing cycle and rising unemployment has simultaneously hurt revenues while increasing costs for unemployment benefits and other social services municipalities often suffer more than corporations during recessions because they do not have the flexibility to reduce costs in the face of declining revenues in fact, their costs rise while revenues decline the Pew center on the states published a report that highlighted, in their words, “states in fiscal Peril” we agree that the word “peril” correctly describes the degree of financial pressure on several issuers we also note the extraordinary actions taken by many states to offset these pressures in order to reduce risks from concentrations in the most stressed states, we are diversifying portfolios away from state of domicile the downside of paying some state tax is offset by diversifying into states that are not facing the same fiscal pressures Pennsylvania is not under as much pressure as other states because of a narrower projected 2010 budget gap and an unemployment rate lower than many other states

we are also attracted to bonds that offer additional and creative forms of bondholder protection in the absence of bond insurance, one example would be the willingness of municipalities to enhance the creditworthiness of their revenue bonds with a pledge of their general obligation credit

the demand for tax-exempt income is a powerful long-term positive for municipal bonds that have kept rates very low despite the states’ financial conditions in our opinion, these financial stresses will likely produce volatility and opportunity in 2010

we believe that the federal reserve will begin to unwind the extraordinary monetary stimulus during 2010 while policy will nonetheless remain accommodative, the unwinding process will result in a flatter yield curve we expect yield spreads to be materially less volatile than the extremes of the past two years within that general trend, there will be events that result in shorter-term volatility the municipal bond market may well be subject to more volatility than other sectors as the demand for after-tax income has driven yields below continuing credit concerns


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2010 outlook

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