Eleven Themes for 2011

RichrdBernstein Eleven Themes for 2011
FloorNew York, NY 100212-692-4000www.rba-llc.com

Here are our eleven investment themes for 2011.  Each of these is either specifically orgenerally embedded in our investment strategies.

1. The US Dollar Continues to Appreciate.
Despite all the talk about debasing the dollar, the DXY Index has actually risen about2% so far in 2010.¹  In addition, most investors remain unaware that the dollar
troughed in April… 2008!  We expect the dollar to continue to appreciate in 2011.

2. The US Outperforms Emerging Markets.
Although the MSCI Emerging Market Index² has outperformed the S&P 500 so far in2010 (15.9% vs.11.9%), the gap is smaller than most investors expected at thebeginning of the year.  Perhaps more important, the S&P 500 has outperformed theBRIC countries (11.9%vs.8.7%), which few people predicted.  Emerging marketsare now leading the world in negative earnings surprises and remain very expensive.We expect the US to outperform the broader emerging markets universe in 2011.

3. Stocks Outperform Bonds.
Stocks and bonds have performed quite similarly so far in 2010.  The S&P 500's total return stands at 11.9%, compared with the 10.4% total return of the BofA MerrillLynch 15+ Year US Treasury Index.  We expect stocks to outperform bonds in 2011as the US economy continues to expand and as normal upward pressure on longer-term interest rates becomes more apparent

4. Gold Produces a Negative Return.
Gold seems to be in a pure momentum market these days.  Momentum markets areexciting, and the media love them, but they have a nasty tendency to fall faster thanthey rose.  The US dollar troughed in 2008, and inflation expectations are not rising in any meaningful way.  We think that next year, gold's momentum market is likely to cede the spotlight  to more fundamentally-based assets like stocks.

5. Longer-Term Treasury Rates Rise by More Than 150 Basis Points.
Our work suggests that the economy is just beginning to enter the mid-phase of theeconomic cycle.  The early-cycle was notably anemic because early-cycle industriesbenefitted the most from the credit bubble, but investors should remember that there
is a cycle.  Our quick review of longer-term interest rates suggests that they typicallyincrease during the mid-phase by between 200 and 300 basis points.  Evenassuming weaker-than-average growth next year, longer-term rates are likely to risesubstantially._______________

6. Energy and Materials Sectors Outperform.
If the economy is indeed beginning to enter the mid-phase of the cycle, then energyand materials stocks begin to take leadership positions.  We expect both globalsectors to outperform in 2011.

7. US Consumer Stocks Outperform EM Consumer Stocks.
According to one fund-manager survey we recently saw, the emerging marketconsumer is the most popular investment theme among emerging-market fundmanagers.  With inflation rising and monetary policies tightening in a growing numberof emerging markets, it seems unlikely that this theme will meet expectations.  Wecontinue to believe that US employment will be stronger than most investors expectnext year, which could produce positive surprises for US consumer stocks.

8. Small-Caps Continue to Dominate Large-Caps Around the World.
The MSCI AC World Small Cap Index has risen 21.7% so far in 2010, which is more
than double the MSCI ACWI's +10.2%.  And yet, investors have generally not
warmed up to smaller companies.  By our calculations, US smaller companies havebeen outperforming China for nearly three years, have twice the 2011 projectedearnings growth of China, and have half the valuation.

9. Muni Bonds Outperform EM Non-Dollar Debt.
We find it curious that investors are so enamored of local-currency-denominatedemerging-market debt, since this sector of the fixed-income markets has historicallybeen the riskiest.  At the other extreme, investors widely believe that US municipalbonds are extremely risky, when they have historically been a far more conservative
investment.  Investors clearly believe that "it will be different this time."  We are not so Sure.

10. Japan Outperforms China.
This is another performance comparison that runs counter to investors' expectations. Japan has outperformed China by more than 800 basis points so far in 2010.  With expectations being so high for China and so low for Japan, we expect Japan's outperformance versus China to continue.