1. MPSIF Economic Update April 5 th, 2004 Stern School of Business New York University

2. Market Trends: Quarter Recap Big markets flat; Small caps continue to outperform Dow Jones Industrial Average ↓ 0.91% Dow Jones Industrial Average ↓ 0.91% S&P 500 ↑ 1.29% S&P 500 ↑ 1.29% NASDAQ Composite ↓ 0.84% since Annual Report NASDAQ Composite ↓ 0.84% since Annual Report Russell 2000 Index ↑ 6.00% Russell 2000 Index ↑ 6.00% 1Q04 earnings expected to be up 17% yoy (above estimate) 1Q04 earnings expected to be up 17% yoy (above estimate) March 2004 dividend up 16.5% over March 2003 March 2004 dividend up 16.5% over March 2003 10-year rates start at 4.15 fall to 3.70 late in March, then return to 4.17 last Friday (rate went up.29% in one day!) 10-year rates start at 4.15 fall to 3.70 late in March, then return to 4.17 last Friday (rate went up.29% in one day!)

3. Economic Fundamentals – Trends and Estimates Fed Rate: Fed Rate: Jobs report increases probability of a Fed increase this summer Jobs report increases probability of a Fed increase this summer Futures prices for July and August suggest a 38% and 70% probability of a 25bp increase by those dates, respectively, up from 16% and 32% the day before the jobs report Futures prices for July and August suggest a 38% and 70% probability of a 25bp increase by those dates, respectively, up from 16% and 32% the day before the jobs report But, these probabilities are down from February, when futures prices were predicting 72% chance of a 25bp increase by July and a 100% chance of a 50bp increase by November But, these probabilities are down from February, when futures prices were predicting 72% chance of a 25bp increase by July and a 100% chance of a 50bp increase by November Triggers are inflation gap and GDP gap… and election? Triggers are inflation gap and GDP gap… and election? GDP: GDP: 4.1% increase in 4Q03. 4.1% increase in 4Q03. Analysts continue to expect 4.5% for 2004. Analysts continue to expect 4.5% for 2004. Inflation: Inflation: Reached a 40 year low of 1.1% in November, expected to rise to 2.0% November 2004 Reached a 40 year low of 1.1% in November, expected to rise to 2.0% November 2004 Import prices have risen 5 consecutive months, but still low. Import prices have risen 5 consecutive months, but still low. Capacity utilization remains low, but rising. Capacity utilization remains low, but rising.

4. Employment Report March Unemployment Rate 5.7%, up from 5.6% March Unemployment Rate 5.7%, up from 5.6% Nonfarm payrolls increased 308,000 Nonfarm payrolls increased 308,000 largest gain since April 2000 1 st month in 44 mfg jobs did not  230K of jump from services Signal that more formerly discouraged workers looking for jobs Signal that more formerly discouraged workers looking for jobs Hourly earnings  measly.1% Hourly earnings  measly.1% Annual rate 1.8% Average workweek 33.7 hours, down a bit from 33.8 Average workweek 33.7 hours, down a bit from 33.8

5. Oil and Gas Outlook OPEC cut production quota by 1 mbbl/d in anticipation of seasonal demand reduction OPEC cut production quota by 1 mbbl/d in anticipation of seasonal demand reduction Until April 1 st, OPEC production at 26 mbbl/day Until April 1 st, OPEC production at 26 mbbl/day OPEC committed to reduce by 1.5 mbbl/d “cheating” ineffective OPEC committed to reduce by 1.5 mbbl/d “cheating” ineffective Decision to cut production contentious within OPEC; Saudis supportive Decision to cut production contentious within OPEC; Saudis supportive OPEC under pressure from U.S. administration OPEC under pressure from U.S. administration Natural pas prices remain high (supply and demand imbalance) Natural pas prices remain high (supply and demand imbalance) Oil and gas one-month futures prices dropped Friday by 3-4% Oil and gas one-month futures prices dropped Friday by 3-4% Caused by strengthened dollar and comments by Kuwaiti and Saudi oil ministers Caused by strengthened dollar and comments by Kuwaiti and Saudi oil ministers Conclusion: Oil tough to call; gas prices likely to remain strong Crude Oil

6. U.S. Currency Markets Friday’s payroll announcement strengthened dollar relative to euro Friday’s payroll announcement strengthened dollar relative to euro ECB continues to focus on inflationary pressures, maintaining higher interest rates ECB continues to focus on inflationary pressures, maintaining higher interest rates Dollar has strengthened against the yen in last three weeks Dollar has strengthened against the yen in last three weeks Japan had purchased 2 / 3 (~¥3.5 t) of its 2003 total through March Japan had purchased 2 / 3 (~¥3.5 t) of its 2003 total through March Indications that intervention slowed dramatically in late-March Indications that intervention slowed dramatically in late-March Japanese and Chinese intervention in currency markets has helped finance U.S.’s current account and budget deficits Japanese and Chinese intervention in currency markets has helped finance U.S.’s current account and budget deficits Conclusion: Increasing growth and subsequent increase in interest rates will lesson support for exporters in near-term; influence unlikely to be felt until 2005 Conclusion: Increasing growth and subsequent increase in interest rates will lesson support for exporters in near-term; influence unlikely to be felt until 2005

7. Fixed Income Outlook Approx. 28% of fund assets are in bond funds Approx. 28% of fund assets are in bond funds Fund charter requires securities to be investment grade Fund charter requires securities to be investment grade ~ 1 / 3 each in treasuries, mortgages, and corporate bonds ~ 1 / 3 each in treasuries, mortgages, and corporate bonds Most spreads over treasuries are below historical level Most spreads over treasuries are below historical level While interest rates stay low, continue receiving coupons While interest rates stay low, continue receiving coupons However, as rates increase over next year, capital losses likely However, as rates increase over next year, capital losses likely Recommendation Recommendation 1. Reduce fixed income holdings (if possible) 2. Rotate into inflation-protected bonds (e.g., TIPS)

8. Fall Presidential Elections Bush/Kerry futures on IEM at 0.52/0.48 Bush/Kerry futures on IEM at 0.52/0.48 As is typical, business supporting Republican over Democrat As is typical, business supporting Republican over Democrat Proportion more lopsided toward Bush than at the end of the Bush/Gore race Proportion more lopsided toward Bush than at the end of the Bush/Gore race Kerry’s “Jobs First” plan focuses on: Kerry’s “Jobs First” plan focuses on: Tax incentives for companies that create jobs domestically Tax incentives for companies that create jobs domestically Slowing the export of jobs abroad Slowing the export of jobs abroad Assisting manufacturing sector Assisting manufacturing sector  Intends to increase taxes on wealthy Bush has not outlined any significant deviations from current policies Bush has not outlined any significant deviations from current policies Has alluded to make U.S. market less litigious (e.g., cap on malpractice awards) Has alluded to make U.S. market less litigious (e.g., cap on malpractice awards) More sensitive industries: legal, real estate, securities & investment, medical More sensitive industries: legal, real estate, securities & investment, medical Conclusion: Bush likely more favorable for global businesses; Kerry for U.S. manufacturing Conclusion: Bush likely more favorable for global businesses; Kerry for U.S. manufacturing

9. Sector Recommendations Overweight: Financials (large cap), Energy, Industrials, Materials, IT, Consumer Discretionary Overweight: Financials (large cap), Energy, Industrials, Materials, IT, Consumer Discretionary Neutral: Health Care, Telecom, Technology, Utilities Neutral: Health Care, Telecom, Technology, Utilities Underweight: Financials (small cap) Underweight: Financials (small cap) Consumer Staples

10. Revisiting the question: Are stocks overvalued? An interesting take from a value perspective Robert Weigand and Robert Irons study suggests that high P/E ratios are no longer mean reverting or indicative of negative future returns. Robert Weigand and Robert Irons study suggests that high P/E ratios are no longer mean reverting or indicative of negative future returns. They also find that high P/E ratios (above 21) have been associated with the highest average of 10 year earnings growth, and a positive 10 year rate of returns, going back to 1881. They also find that high P/E ratios (above 21) have been associated with the highest average of 10 year earnings growth, and a positive 10 year rate of returns, going back to 1881. It seems that interest rates, at least since 1960, are a better predictor of earnings and returns. It seems that interest rates, at least since 1960, are a better predictor of earnings and returns. All of this suggests P/E ratios can deviate from the historical mean for long periods of time, or even permanently. All of this suggests P/E ratios can deviate from the historical mean for long periods of time, or even permanently.

11. While P/E ratios have deviated significantly from their historical mean… Source: Weingand & Irons, The Market P/E Ratio: Stock Returns, Earnings, and Mean Reversion

12. …E/P ratios have become cointegrated with 10-year Yield Source: Weingand & Irons, The Market P/E Ratio: Stock Returns, Earnings, and Mean Reversion

13. E/P ratios and 10-year yield – what it all means for investors The 10-year rate and E/P ratios are highly, and positively correlated, meaning that P/E ratios are negatively correlated with the 10-year yield The 10-year rate and E/P ratios are highly, and positively correlated, meaning that P/E ratios are negatively correlated with the 10-year yield Investors should keep a close eye on interest rates Investors should keep a close eye on interest rates A bearish view on bonds means a bullish view on equities A bearish view on bonds means a bullish view on equities Historical P/E ratios, at least for the market, are irrelevant! Historical P/E ratios, at least for the market, are irrelevant!