GLOBAL EQUITY RESEARCH

Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.

Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this

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Investors should consider this report as only a single factor in making their investment decision.

PLEASE REFER TO THE BACK COVER FOR ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES.

High Equity Risk Premium in a Low Volatility World In a post-bubble equity environment, low realized and implied volatility are consistent with a high equity risk premium and low credit spreads, as investors assign relatively higher valuations to fixed income than equities.

The existing mindset of the large-cap equity investors appears to be one of a high degree of investor caution and lack of conviction.

The equity risk premium remains above the 80th percentile, while current levels of realized volatility are close to the bottom end of their 75-year-plus range. Trading volumes remain relatively flat over the last four years.

We recommend overweighting equities and underweighting fixed income in anticipation of stronger equity market conditions supported by valuation and driven by rising levels of corporate actions and the end of the Fed tightening cycle.

Figure 1: S&P 500 Return Volatility History

0%

10%

20%

30%

40%

50%

60%

1/1/

1928

1/1/

1932

1/1/

1936

1/1/

1940

1/1/

1944

1/1/

1948

1/1/

1952

1/1/

1956

1/1/

1960

1/1/

1964

1/1/

1968

1/1/

1972

1/1/

1976

1/1/

1980

1/1/

1984

1/1/

1988

1/1/

1992

1/1/

1996

1/1/

2000

1/1/

2004

0

10

20

30

40

50

60

Annualized Rolling 252 Day St. Dev. Of S&P 500 Price Return VIX - 50 Day Moving Average

Realized Volatility VIX - Implied Volatility

Source: Lehman Brothers and Global Financial Data

UNITED STATES INVESTMENT STRATEGY

& MACRO U.S. Strategy

Henry C. Dickson, CFA 1.212.526.5659

cdickson@lehman.com

Raheel Siddiqui 1.212.526.4250

raheel.siddiqui@lehman.com

Brett Kornfeld 1.212.526.1862

brett.kornfeld@lehman.com

February 1, 2006

http://www.lehman.com

High Equity Risk Premium in a Low Volatility World

2 February 1, 2006

High (Low) Risk Premium Tracks Low (High) Volatility

Since 1989, the realized S&P 500 volatility1 closely tracked the inverse of the ratio of the Fed Model (the P/E equivalent of the 10-year Treasury) relative to the S&P 500 trailing P/E. Currently, investors are paying a 35% premium for 10-year Treasury Bonds relative to the market, and S&P 500 volatility is at the low end of the range (see Figure 2). We believe this relationship is not a contradiction, but one that is consistent with a post-bubble environment for large-cap equities. It reflects a high level of caution and lack of conviction in large cap equities, in our opinion.

Figure 2: Realized Volatility and Risk Premium Since 1989

0%

5%

10%

15%

20%

25%

30%Ja

n-89

Jan-

90

Jan-

91

Jan-

92

Jan-

93

Jan-

94

Jan-

95

Jan-

96

Jan-

97

Jan-

98

Jan-

99

Jan-

00

Jan-

01

Jan-

02

Jan-

03

Jan-

04

Jan-

05

Jan-

06

0.4

0.6

0.8

1.0

1.2

1.4

1.6

Realized S&P 500 Volatility Lagged One Year

Ratio of Fed Model (1/10 Year Treasury Yield) to S&P 500 Trailing P/E

S&P 500 Volatility Valuation Ratio (Inverted)

Source: Lehman Brothers and Global Financial Data

The current level of realized volatility is at the 8th percentile since 1926, while the equity risk premium remains above its 80th percentile. Typically, periods of high equity risk premiums are followed by positive equity returns over the next 12-18 months.

According to Lehman's Equity Derivatives Strategy team, both implied and realized volatility for the S&P 500 and single stocks should trade a few volatility points higher in 2006 relative to 2005. Potential catalysts include credit concerns, an uncertain interest rate outlook, housing market weakness, volatile energy prices, reversion in the volatility risk premium, and event risks such as the 2006 U.S. Congressional elections, geopolitical concerns, and avian flu.2

1 Please see the appendix to this report on page 12 for our definitions of realized and implied

volatility.

2 Please see “Options Strategy Monthly: Low Volatility in the 7th Inning?” (1/10/06), Ryan

Renicker, for further details.

High Equity Risk Premium in a Low Volatility World

February 1, 2006 3

Our asset allocation recommendations include overweighting equities and underweighting fixed income (see Figure 14). This stance reflects our view that the equity risk premium should decline driven by the end of the Fed tightening cycle, solid earnings and economic growth, and continued redeployment of ever rising cash levels back to investors.

High Equity Risk Premium in a Low Volatility World

4 February 1, 2006

A Long Look Back at Equity Risk Premium

Since 1962 the equity risk premium (ERP) rose to peak levels when periods of market euphoria ended badly and during periods of financial stress (see Figure 3). We believe the prolonged period of high risk premium is a reflection of the post-bubble environment weighing on large-cap equities. The aforementioned catalysts and moderation of headwinds generated by rising energy costs for instance, should help reduce the ERP and provide a real exit from the bubble environment.

Figure 3: The Fed Model of Risk Premium Is in the 82nd Percentile Since 1962: Inverse of 10-Year Treasury Yield/S&P 500 Forward P/E

0.4

0.6

0.8

1.01.2

1.4

1.6

1.8

2.0

Mar-62

Mar-66

Mar-70

Mar-74

Mar-78

Mar-82

Mar-86

Mar-90

Mar-94

Mar-98

Mar-02

1/(10 Yr Constant Maturity Treasury Yield) / S&P 500 Reported P/E

Source: Lehman Brothers, Global Financial Data, FactSet, and Thomson Financial

Along with the rising level of the ERP has been a flattening in the level of market volumes, which is more pronounced when the changing nature of the stock market is considered. As of December 31, 2005, program trading represented 64% of NYSE volume compared to 19% at the end of 1999. In contrast, block trading represented 19% of volume in S&P 500 names compared to 28% at the end of 1999.

High Equity Risk Premium in a Low Volatility World

February 1, 2006 5

Figure 4: NYSE and Nasdaq Volumes Since 1990

0

500

1,000

1,500

2,000

2,500

1/1/

90

1/1/

91

1/1/

92

1/1/

93

1/1/

94

1/1/

95

1/1/

96

1/1/

97

1/1/

98

1/1/

99

1/1/

00

1/1/

01

1/1/

02

1/1/

03

1/1/

04

1/1/

05

1/1/

06

NYSE Volume - 100 Day Moving Average

NASDAQ Composite Volume - 100 Day Moving Average

Volume (Millions of Shares)

Source: Lehman Brothers and Global Financial Data

High Equity Risk Premium in a Low Volatility World

6 February 1, 2006

Style, Asset Class, and Sector Comments

Growth and Value Style Indices: Since 2000, the realized volatility levels of the Russell 1000 Growth and Value indices have converged as Value outperformed Growth.

Figure 5: Realized Volatility of Russell 1000 Style Indices Since 1995

0%

10%

20%

30%

40%

5/31

/199

5

5/31

/199

6

5/31

/199

7

5/31

/199

8

5/31

/199

9

5/31

/200

0

5/31

/200

1

5/31

/200

2

5/31

/200

3

5/31

/200

4

5/31

/200

5

Russell 1000 Growth Russell 1000 Value

Source: Lehman Brothers and Global Financial Data

Large-, Mid- and Small-Caps: Since the market trough of early 2003, the S&P SmallCap 600 has shown more realized volatility than the S&P MidCap 400 which, in turn, has been more volatile than the S&P 500. We think this situation reflects greater investor interest in the Mid and Small Caps. The post bubble blues seem to be mostly a Large Cap phenomenon.

High Equity Risk Premium in a Low Volatility World

February 1, 2006 7

Figure 6: Realized Volatility of S&P Mid- and Small-Cap Indices Relative to S&P 500 Since 1980

0.00.20.40.60.81.01.21.41.61.8

12/3

1/19

79

12/3

1/19

81

12/3

1/19

83

12/3

1/19

85

12/3

1/19

87

12/3

1/19

89

12/3

1/19

91

12/3

1/19

93

12/3

1/19

95

12/3

1/19

97

12/3

1/19

99

12/3

1/20

01

12/3

1/20

03

12/3

1/20

05

S&P MidCap 400 Relative to S&P 500

S&P SmallCap 600 Relative to S&P 500

Source: Lehman Brothers and Global Financial Data

Gold and Oil: These commodities have shown more historical realized volatility than Large-Cap equities. Recently, gold has been less volatile as despite rapid price changes, daily returns have been fairly steady.

Figure 7: Realized Volatility of WTI Oil and Gold Versus the S&P 500

0%10%20%30%40%50%60%70%80%90%

12/3

1/19

69

12/3

1/19

71

12/3

1/19

73

12/3

1/19

75

12/3

1/19

77

12/3

1/19

79

12/3

1/19

81

12/3

1/19

83

12/3

1/19

85

12/3

1/19

87

12/3

1/19

89

12/3

1/19

91

12/3

1/19

93

12/3

1/19

95

12/3

1/19

97

12/3

1/19

99

12/3

1/20

01

12/3

1/20

03

12/3

1/20

05

S&P 500 Gold Oil

Source: Lehman Brothers and Global Financial Data

Investment Grade Fixed Income: Historically, bonds have been much less volatile than equities. Credit spreads remain narrow, given the strong financial condition of Corporate America and a demand supply imbalance. We expect supply to increase in order to fund more M&A and underfunded pension plans.

High Equity Risk Premium in a Low Volatility World

8 February 1, 2006

Figure 8: Realized Volatility of the Lehman U.S. Aggregate Versus the S&P 500

0%

5%

10%

15%

20%

25%

30%

12/3

1/19

89

12/3

1/19

90

12/3

1/19

91

12/3

1/19

92

12/3

1/19

93

12/3

1/19

94

12/3

1/19

95

12/3

1/19

96

12/3

1/19

97

12/3

1/19

98

12/3

1/19

99

12/3

1/20

00

12/3

1/20

01

12/3

1/20

02

12/3

1/20

03

12/3

1/20

04

12/3

1/20

05

0%

1%

2%

3%

4%

5%

6%

7%

S&P 500 Lehman U.S. Aggregate

S&P 500 Lehman U.S. Aggregate

Source: Lehman Brothers and Global Financial Data

S&P 500 Sectors: Energy has been the most volatile. Volatility in the Utilities sector began to pick up at the beginning of 2004. Volatility trends for the other sectors have been down to stable, with many sectors exhibiting realized volatility at the very bottom of their historical range.

Historical realized volatility by S&P 500 GICS sector is presented in Figure 9. In order to present more history, selected industry and industry group charts are presented in Figure 10. Many industry-specific charts show similar trends to the sector charts. A few differences include the apparent turn in volatility for Chemicals, Property & Casualty Insurance and the Banks. Also, please note the most volatile time since 1950 for Banks was during the S&L Crisis and not during the market bubble or immediately after the 1987 crash.

Realized volatility data is available upon request at the S&P 500 sub-industry level. Due to the low number of companies in each sub-industry, many sub-industries appear more volatile than the market simply because only one or two stocks are included, negating any potential diversification effects.

High Equity Risk Premium in a Low Volatility World

February 1, 2006 9

Figure 9: Historical Realized Volatility by S&P 500 GICS Sector

0%

10%

20%

30%

40%

50%

60%

12/3

1/19

26

12/3

1/19

30

12/3

1/19

34

12/3

1/19

38

12/3

1/19

42

12/3

1/19

46

12/3

1/19

50

12/3

1/19

54

12/3

1/19

58

12/3

1/19

62

12/3

1/19

66

12/3

1/19

70

12/3

1/19

74

12/3

1/19

78

12/3

1/19

82

12/3

1/19

86

12/3

1/19

90

12/3

1/19

94

12/3

1/19

98

12/3

1/20

02

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price Returns

Annualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Consumer Discretionary

0%

10%

20%

30%

40%

50%

60%

12/3

1/19

26

12/3

1/19

30

12/3

1/19

34

12/3

1/19

38

12/3

1/19

42

12/3

1/19

46

12/3

1/19

50

12/3

1/19

54

12/3

1/19

58

12/3

1/19

62

12/3

1/19

66

12/3

1/19

70

12/3

1/19

74

12/3

1/19

78

12/3

1/19

82

12/3

1/19

86

12/3

1/19

90

12/3

1/19

94

12/3

1/19

98

12/3

1/20

02

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Consumer Staples

0%

5%

10%

15%

20%

25%

30%

35%

12/3

1/19

86

12/3

1/19

87

12/3

1/19

88

12/3

1/19

89

12/3

1/19

90

12/3

1/19

91

12/3

1/19

92

12/3

1/19

93

12/3

1/19

94

12/3

1/19

95

12/3

1/19

96

12/3

1/19

97

12/3

1/19

98

12/3

1/19

99

12/3

1/20

00

12/3

1/20

01

12/3

1/20

02

12/3

1/20

03

12/3

1/20

04

12/3

1/20

05Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Energy

0%5%

10%15%20%25%30%35%40%

12/3

1/19

71

12/3

1/19

73

12/3

1/19

75

12/3

1/19

77

12/3

1/19

79

12/3

1/19

81

12/3

1/19

83

12/3

1/19

85

12/3

1/19

87

12/3

1/19

89

12/3

1/19

91

12/3

1/19

93

12/3

1/19

95

12/3

1/19

97

12/3

1/19

99

12/3

1/20

01

12/3

1/20

03

12/3

1/20

05

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Financials

0%

5%

10%

15%

20%

25%

30%

35%

12/3

1/19

87

12/3

1/19

88

12/3

1/19

89

12/3

1/19

90

12/3

1/19

91

12/3

1/19

92

12/3

1/19

93

12/3

1/19

94

12/3

1/19

95

12/3

1/19

96

12/3

1/19

97

12/3

1/19

98

12/3

1/19

99

12/3

1/20

00

12/3

1/20

01

12/3

1/20

02

12/3

1/20

03

12/3

1/20

04

12/3

1/20

05

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Health Care

0%10%20%30%40%50%60%70%80%

12/3

1/19

26

12/3

1/19

30

12/3

1/19

34

12/3

1/19

38

12/3

1/19

42

12/3

1/19

46

12/3

1/19

50

12/3

1/19

54

12/3

1/19

58

12/3

1/19

62

12/3

1/19

66

12/3

1/19

70

12/3

1/19

74

12/3

1/19

78

12/3

1/19

82

12/3

1/19

86

12/3

1/19

90

12/3

1/19

94

12/3

1/19

98

12/3

1/20

02

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Industrials

0%

10%

20%

30%

40%

50%

60%

70%

12/3

1/19

86

12/3

1/19

87

12/3

1/19

88

12/3

1/19

89

12/3

1/19

90

12/3

1/19

91

12/3

1/19

92

12/3

1/19

93

12/3

1/19

94

12/3

1/19

95

12/3

1/19

96

12/3

1/19

97

12/3

1/19

98

12/3

1/19

99

12/3

1/20

00

12/3

1/20

01

12/3

1/20

02

12/3

1/20

03

12/3

1/20

04

12/3

1/20

05

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Information Technology

0%

5%

10%

15%

20%

25%

30%

35%

9/30

/199

0

9/30

/199

1

9/30

/199

2

9/30

/199

3

9/30

/199

4

9/30

/199

5

9/30

/199

6

9/30

/199

7

9/30

/199

8

9/30

/199

9

9/30

/200

0

9/30

/200

1

9/30

/200

2

9/30

/200

3

9/30

/200

4

9/30

/200

5

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Materials

0%5%

10%15%20%25%30%35%40%45%50%

9/30

/199

0

9/30

/199

1

9/30

/199

2

9/30

/199

3

9/30

/199

4

9/30

/199

5

9/30

/199

6

9/30

/199

7

9/30

/199

8

9/30

/199

9

9/30

/200

0

9/30

/200

1

9/30

/200

2

9/30

/200

3

9/30

/200

4

9/30

/200

5

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Telecom

0%

10%

20%

30%

40%

50%

60%

70%

1/2/

1919

1/2/

1924

1/2/

1929

1/2/

1934

1/2/

1939

1/2/

1944

1/2/

1949

1/2/

1954

1/2/

1959

1/2/

1964

1/2/

1969

1/2/

1974

1/2/

1979

1/2/

1984

1/2/

1989

1/2/

1994

1/2/

1999

1/2/

2004

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Utilities

Source: Lehman Brothers and Global Financial Data

High Equity Risk Premium in a Low Volatility World

10 February 1, 2006

Figure 10: Historical Realized Volatility for Selected S&P 500 GICS Industry Groups and Industries Where Available Sector Data Does Not Provide a Long History

0%

10%

20%

30%

40%

50%

60%1/

2/19

19

1/2/

1923

1/2/

1927

1/2/

1931

1/2/

1935

1/2/

1939

1/2/

1943

1/2/

1947

1/2/

1951

1/2/

1955

1/2/

1959

1/2/

1963

1/2/

1967

1/2/

1971

1/2/

1975

1/2/

1979

1/2/

1983

1/2/

1987

1/2/

1991

1/2/

1995

1/2/

1999

1/2/

2003

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Oil, Gas, and Combustible Fuels

0%

10%

20%

30%

40%

50%

60%

70%

1/2/

1919

1/2/

1922

1/2/

1925

1/2/

1928

1/2/

1931

1/2/

1934

1/2/

1937

1/2/

1940

1/2/

1943

1/2/

1946

1/2/

1949

1/2/

1952

1/2/

1955

1/2/

1958

1/2/

1961

1/2/

1964

1/2/

1967

1/2/

1970

1/2/

1973

1/2/

1976

1/2/

1979

1/2/

1982

1/2/

1985

1/2/

1988

1/2/

1991

1/2/

1994

1/2/

1997

1/2/

2000

1/2/

2003

1/2/

2006

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Computer Hardware

0%

10%

20%

30%

40%

50%

60%

70%

80%

1/2/

1970

1/2/

1972

1/2/

1974

1/2/

1976

1/2/

1978

1/2/

1980

1/2/

1982

1/2/

1984

1/2/

1986

1/2/

1988

1/2/

1990

1/2/

1992

1/2/

1994

1/2/

1996

1/2/

1998

1/2/

2000

1/2/

2002

1/2/

2004

1/2/

2006

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Semiconductors

0%

10%

20%

30%

40%

50%

60%

12/3

1/19

26

12/3

1/19

29

12/3

1/19

32

12/3

1/19

35

12/3

1/19

38

12/3

1/19

41

12/3

1/19

44

12/3

1/19

47

12/3

1/19

50

12/3

1/19

53

12/3

1/19

56

12/3

1/19

59

12/3

1/19

62

12/3

1/19

65

12/3

1/19

68

12/3

1/19

71

12/3

1/19

74

12/3

1/19

77

12/3

1/19

80

12/3

1/19

83

12/3

1/19

86

12/3

1/19

89

12/3

1/19

92

12/3

1/19

95

12/3

1/19

98

12/3

1/20

01

12/3

1/20

04

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Pharmaceuticals

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

1/2/

1956

1/2/

1958

1/2/

1960

1/2/

1962

1/2/

1964

1/2/

1966

1/2/

1968

1/2/

1970

1/2/

1972

1/2/

1974

1/2/

1976

1/2/

1978

1/2/

1980

1/2/

1982

1/2/

1984

1/2/

1986

1/2/

1988

1/2/

1990

1/2/

1992

1/2/

1994

1/2/

1996

1/2/

1998

1/2/

2000

1/2/

2002

1/2/

2004

1/2/

2006

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Property & Casualty Insurance

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

1/2/

1951

1/2/

1954

1/2/

1957

1/2/

1960

1/2/

1963

1/2/

1966

1/2/

1969

1/2/

1972

1/2/

1975

1/2/

1978

1/2/

1981

1/2/

1984

1/2/

1987

1/2/

1990

1/2/

1993

1/2/

1996

1/2/

1999

1/2/

2002

1/2/

2005

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Banks

0%

10%

20%

30%

40%

50%

60%

70%

80%

12/3

1/19

26

12/3

1/19

30

12/3

1/19

34

12/3

1/19

38

12/3

1/19

42

12/3

1/19

46

12/3

1/19

50

12/3

1/19

54

12/3

1/19

58

12/3

1/19

62

12/3

1/19

66

12/3

1/19

70

12/3

1/19

74

12/3

1/19

78

12/3

1/19

82

12/3

1/19

86

12/3

1/19

90

12/3

1/19

94

12/3

1/19

98

12/3

1/20

02

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Chemicals

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1/2/

1919

1/2/

1923

1/2/

1927

1/2/

1931

1/2/

1935

1/2/

1939

1/2/

1943

1/2/

1947

1/2/

1951

1/2/

1955

1/2/

1959

1/2/

1963

1/2/

1967

1/2/

1971

1/2/

1975

1/2/

1979

1/2/

1983

1/2/

1987

1/2/

1991

1/2/

1995

1/2/

1999

1/2/

2003

Annualized Rolling 252 Trading Day St,. Dev. Of S&P 500 Sector Price ReturnsAnnualized Rolling 52 Week St. Dev. Of S&P 500 Sector Price Returns

Integrated Telecom

Source: Lehman Brothers and Global Financial Data

High Equity Risk Premium in a Low Volatility World

February 1, 2006 11

Investment Conclusion

Low S&P 500 volatility levels are consistent with a high equity risk premium and low credit spreads as investors assign relatively higher valuations to fixed income than equities. We believe the current environment reflects a high degree of investor caution and lack of conviction and these factors are consistent with a post-bubble environment. We reiterate our overweight position on equities and underweight position on fixed income (see Figure 14).

High Equity Risk Premium in a Low Volatility World

12 February 1, 2006

Appendix: Realized and Implied Volatility

Our measure of realized volatility is defined simply: we look at the trailing 252-trading day series of price returns for a particular index and take the annualized standard deviation of that series. As such, our measure is, by definition, backwards looking. Moreover, any one-day event such as the 1987 market crash will continue to drive our realized volatility measure higher for 252 trading days.

For a forward-looking measure, we consider implied volatility through the CBOE S&P 500 Volatility Index (VIX). History for this index is only available back to 1986. Since 1986 we have seen a 0.83 correlation between our realized volatility measure and the 50-day moving average of the VIX (see Figure 11). Both our realized volatility measure and the VIX index are at low levels relative to their history (see Figures 12 and 13).

Figure 11: Implied Versus Realized S&P 500 Volatility

0%5%

10%15%20%25%30%35%40%

1/1/

1986

1/1/

1987

1/1/

1988

1/1/

1989

1/1/

1990

1/1/

1991

1/1/

1992

1/1/

1993

1/1/

1994

1/1/

1995

1/1/

1996

1/1/

1997

1/1/

1998

1/1/

1999

1/1/

2000

1/1/

2001

1/1/

2002

1/1/

2003

1/1/

2004

1/1/

2005

1/1/

2006

0

10

20

30

40

50

60

Annualized Rolling 252 Day St. Dev. Of S&P 500 Price ReturnVIX - 50 Day Moving Average

Realized Volatility VIX - Implied Volatility

Source: Lehman Brothers and Global Financial Data

High Equity Risk Premium in a Low Volatility World

February 1, 2006 13

Figure 12: Currently Observed Realized Volatility Is Low but Not Excessively So

0%

5%

10%

15%

20%

25%

Frequency of Daily Measures of S&P 500 Trailing 252 Day Realized Volatility Since November 1928

Current Value = 10.4%

Note: Current value as of market close on January 27, 2006. Source: Lehman Brothers and Global Financial Data

Figure 13: Implied Volatility Is Also Low but Not Excessively So

0%

2%

4%

6%

8%

10%

12%

14%

16%

Frequency of Daily VIX Levels Since January 1986

Current Value = 11.97

Note: Current value as of market close on January 27, 2006. Source: Lehman Brothers and Global Financial Data

High Equity Risk Premium in a Low Volatility World

14 February 1, 2006

Figure 14: Asset Allocation Recommendations Lehman Brothers U.S.Equity Strategy Allocation

65.0% Equities 15.0% Fixed Income 20.0% Cash

Benchmark Allocation

60.0% Equities 30.0% Fixed Income 10.0% Cash

Source: Lehman Brothers

Figure 15: Lehman Brothers U.S. Equity Strategy Price Targets and EPS ForecastsS&P 500 Forecasts

2005 Earnings Forecast 2006 Earnings Forecast 2007 Earnings Forecast$76.25 per share $82.75 per share $88.50 per share

13.6% Y-o-Y Growth 8.5% Y-o-Y Growth 7.0% Y-o-Y Growth

12-Month Price Target1400

S&P MidCap 400 Forecasts

2004 Earnings Actual 2005 Earnings Forecast 2006 Earnings Forecast

$33.33 per share $38.00 per share $44.00 per share18.0% Y-o-Y Growth 14.0% Y-o-Y Growth 15.8% Y-o-Y Growth

12-Month Price Target800

Dow Jones Industrials Forecasts

12-Month Price Target12,000

Note: Our 12-month forward price target for the S&P 500 assumes EPS growth of 13.6% in 2005, 8.2% in 2006, 7.0% in 2007, and 6.0% annual growth thereafter; a near 5.0% yield on the 10-year Treasury; a decline in the index's forward risk premium to 4.5% that still leaves it above its median level since 1982; and a forward P/E ratio of 15.8x. The forward P/E assumption is in line with levels since 1962 given the existing inflation and interest rate environment. Our 12-month forward price target for the S&P MidCap 400 assumes EPS growth of 14.0% in 2005 and 15.8% in 2006; a 4.70% yield on the 10-year Treasury; a decline in the index's forward risk premium; and a forward P/E ratio of 17.2x. Our 12-month forward price target for the Dow Jones Industrials is set in tandem with the S&P 500 price target and modestly risk-adjusted. It assumes similar long-term earnings growth rates and levels of risk premium. Source: Lehman Brothers

Figure 16: Lehman Brothers U.S. Equity Strategy Sector Weighting Recommendations

S&P 500 Sector Recommended Weightings

Overweight Market Weight UnderweightEnergy Information Technology Consumer Discretionary

Financials Telecommunications Services Consumer StaplesHealth Care Materials UtilitiesIndustrials

Source: Lehman Brothers

February 1

, 20

06

15

High Equity Risk Prem

ium in a Low

Volatility World

Figure 17: Lehman Brothers U.S. Equity Strategy Model Portfolio Holdings Core Growth Value

Ticker Sector or CompanyBenchmark

WeightLehman Weight Price Ticker Sector or Company

S&P Benchmark

WeightLehman Weight Price Ticker Sector or Company

S&P Benchmark

WeightLehman Weight Price

Consumer Discretionary Sector 10.7 8.8 -- Consumer Discretionary Sector 12.6 7.2 -- Consumer Discretionary Sector 8.7 10.8 --COH Coach Inc. 0.1 2.4 $35.95 BBY Best Buy Co. Inc. 0.4 2.6 $50.66 MCD McDonald's Corp. 0.4 2.0 $35.01MCD McDonald's Corp. 0.4 1.0 $35.01 COH Coach Inc. 0.2 1.5 $35.95 ORLY O'Reilly Automotive Inc. -- 3.1 $32.82ORLY O'Reilly Automotive Inc. -- 1.4 $32.82 EBAY eBay Inc. 0.8 0.8 $43.10 PHM Pulte Homes Inc. 0.2 2.0 $39.90PHM Pulte Homes Inc. 0.1 1.7 $39.90 LOW Lowe's Cos. 0.8 2.2 $63.55 SPLS Staples Inc. 0.1 2.7 $23.71SPLS Staples Inc. 0.2 2.3 $23.71 Consumer Staples Sector 13.7 11.6 -- TGT Target Corp. -- 1.2 $54.75

Consumer Staples Sector 9.3 7.0 -- BUD Anheuser-Busch Cos. Inc. 0.5 1.9 $41.44 Consumer Staples Sector 4.8 1.6 --CVS CVS Corp. 0.2 2.0 $27.76 HSY Hershey Co. 0.1 2.4 $51.20 CVS CVS Corp. 0.4 1.6 $27.76KO Coca-Cola Co. 0.7 1.5 $41.38 KO Coca-Cola Co. 0.8 1.9 $41.38 Energy Sector 8.8 12.8 --PG Procter & Gamble Co. 1.7 2.1 $59.23 PG Procter & Gamble Co. 3.4 2.9 $59.23 ACI Arch Coal Inc. -- 1.6 $86.72WMT Wal-Mart Stores Inc. 1.0 1.4 $46.11 WMT Wal-Mart Stores Inc. 2.0 2.5 $46.11 KMG Kerr-McGee Corp. 0.1 4.5 $110.39

Energy Sector 10.3 13.6 -- Energy Sector 11.8 11.8 -- MRO Marathon Oil Corp. 0.5 2.8 $76.87KMG Kerr-McGee Corp. 0.1 4.2 $110.39 EOG EOG Resources Inc. 0.3 4.2 $84.54 XOM Exxon Mobil Corp. 2.5 3.9 $62.75RIG Transocean Inc. 0.2 3.5 $81.15 RIG Transocean Inc. 0.2 3.1 $81.15 Financials Sector 31.9 37.5 --SLB Schlumberger Ltd. 0.6 2.8 $127.45 SLB Schlumberger Ltd. 0.5 3.0 $127.45 AIG American International Group Inc. 1.3 4.4 $65.46XOM Exxon Mobil Corp. 3.4 1.3 $62.75 XTO XTO Energy Inc. 0.3 1.5 $49.08 ALL Allstate Corp. 0.6 2.8 $52.05XTO XTO Energy Inc. 0.2 1.9 $49.08 Financials Sector 10.1 5.6 -- C Citigroup Inc. 4.1 3.8 $46.58

Financials Sector 20.8 21.9 -- AMP Ameriprise Financial Inc. 0.1 0.3 $40.69 CIT CIT Group Inc. 0.2 5.9 $53.34AIG American International Group Inc. 1.5 2.3 $65.46 AXP American Express Co. 1.1 1.4 $52.45 MEL Mellon Financial Corp. 0.2 2.4 $35.27ALL Allstate Corp. 0.3 1.7 $52.05 BEN Franklin Resources Inc. 0.1 1.8 $98.50 MER Merrill Lynch & Co. Inc. 1.2 4.7 $75.07AMP Ameriprise Financial Inc. 0.1 0.4 $40.69 COF Capital One Financial Corp. 0.4 1.3 $83.30 USB U.S. Bancorp 1.0 3.6 $29.91AXP American Express Co. 0.6 1.9 $52.45 FII Federated Investors Inc. 0.1 0.9 $38.61 WB Wachovia Corp. 1.5 3.7 $54.83BEN Franklin Resources Inc. 0.1 3.6 $98.50 Health Care Sector 21.8 23.8 -- WFC Wells Fargo & Co. 1.8 3.8 $62.36C Citigroup Inc. 2.0 2.5 $46.58 ABI Applied Biosystems Group - Applera Corp. 0.1 2.5 $28.34 WM Washington Mutual Inc. 0.7 2.5 $42.32CIT CIT Group Inc. 0.1 1.5 $53.34 AMGN Amgen Inc. 1.5 3.2 $72.89 Health Care Sector 4.2 6.9 --COF Capital One Financial Corp. 0.2 1.3 $83.30 DGX Quest Diagnostics Inc. 0.1 1.2 $49.43 CMX Caremark Rx Inc. -- 1.4 $49.30MER Merrill Lynch & Co. Inc. 0.6 3.1 $75.07 GILD Gilead Sciences Inc. 0.5 3.4 $60.87 ESRX Express Scripts Inc. -- 4.1 $91.29USB U.S. Bancorp 0.5 0.9 $29.91 PFE Pfizer Inc. 3.2 2.3 $25.68 HMA Health Management Associates Inc. -- 1.4 $21.02WFC Wells Fargo & Co. 0.9 2.6 $62.36 STJ St. Jude Medical Inc. 0.3 2.3 $49.13 Industrials Sector 14.8 8.4 --

Health Care Sector 13.2 13.7 -- TEVA Teva Pharmaceutical Industries Ltd. -- 4.1 $42.63 CD Cendant Corp. -- 1.1 $16.74CMX Caremark Rx Inc. 0.2 0.8 $49.30 UNH UnitedHealth Group Inc. 1.4 4.8 $59.42 EMR Emerson Electric Co. 0.6 1.3 $77.45DGX Quest Diagnostics Inc. 0.1 2.9 $49.43 Industrials Sector 7.3 13.6 -- PNR Pentair Inc. -- 2.9 $38.40HMA Health Management Associates Inc. 0.0 0.8 $21.02 DHR Danaher Corp. 0.2 4.1 $56.64 UTX United Technologies Corp. 1.0 1.6 $58.37PFE Pfizer Inc. 1.6 2.8 $25.68 GE General Electric Co. 2.8 2.3 $32.75 WMI Waste Management Inc. 0.1 1.6 $31.58STJ St. Jude Medical Inc. 0.2 2.5 $49.13 ITW Illinois Tool Works Inc. 0.1 1.5 $84.29 Information Technology Sector 9.6 6.6 --TEVA Teva Pharmaceutical Industries Ltd. -- 2.1 $42.63 LUV Southwest Airlines Co. 0.1 2.6 $16.46 CSC Computer Sciences Corp. 0.2 1.9 $50.70UNH UnitedHealth Group Inc. 0.7 1.8 $59.42 MMM 3M Co. 0.6 1.9 $72.75 DELL Dell Inc. -- 2.6 $29.31

Industrials Sector 11.0 11.5 -- UPS United Parcel Service Inc. 0.9 1.2 $74.91 MU Micron Technology Inc. 0.2 2.1 $14.68CD Cendant Corp. 0.1 1.4 $16.74 Information Technology Sector 20.5 25.5 -- Materials Sector 5.0 5.7 --DHR Danaher Corp. 0.1 1.5 $56.64 ADBE Adobe Systems Inc. 0.4 2.6 $39.73 PD Phelps Dodge Corp. 0.3 5.7 $160.50EMR Emerson Electric Co. 0.3 1.5 $77.45 CKFR CheckFree Corp. -- 4.9 $51.82 Telecommunication Services Sector 6.1 5.3 --GE General Electric Co. 3.0 2.5 $32.75 CSCO Cisco Systems Inc. 1.9 0.5 $18.57 S Sprint Nextel Corp. 1.2 2.3 $22.89ITW Illinois Tool Works Inc. 0.1 1.4 $84.29 GLW Corning Inc. 0.2 1.4 $24.35 T AT&T Inc. 1.8 1.6 $25.95UTX United Technologies Corp. 0.5 1.6 $58.37 INTC Intel Corp. 1.1 3.4 $21.26 VZ Verizon Communications Inc. 1.6 1.4 $31.66WMI Waste Management Inc. 0.2 1.5 $31.58 INTU Intuit Inc. 0.2 3.0 $52.33 Utilities Sector 6.0 4.3 --

Information Technology Sector 15.2 14.3 -- MSFT Microsoft Corp. 4.4 4.0 $28.15 EXC Exelon Corp. 0.3 2.5 $57.42CKFR CheckFree Corp. -- 2.8 $51.82 NTAP Network Appliance Inc. 0.2 1.5 $31.20 PPL PPL Corp. 0.2 1.8 $30.13DELL Dell Inc. 0.6 1.9 $29.31 TXN Texas Instruments Inc. 0.4 4.2 $29.23GLW Corning Inc. 0.3 1.7 $24.35 Materials Sector 1.1 0.9 -- Returns Since Model Portfolio Inception (9/2/2003):INTC Intel Corp. 1.1 2.5 $21.26 PX Praxair Inc. 0.2 0.9 $52.68 Lehman Brothers U.S. Equity Strategy Model Value Portfolio 53.39MSFT Microsoft Corp. 2.2 2.7 $28.15 S&P 500 Value 40.10NTAP Network Appliance Inc. 0.1 2.7 $31.20 Returns Since Model Portfolio Inception (9/2/2003): Russell 1000 Value 44.56

Materials Sector 3.0 4.0 -- Lehman Brothers U.S. Equity Strategy Model Growth Portfolio 30.25 Returns Since Beginning of Year (1/1/2006):PD Phelps Dodge Corp. 0.1 4.0 $160.50 S&P 500 Growth 21.80 Lehman Brothers U.S. Equity Strategy Model Value Portfolio 4.56

Telecommunication Services Sector 3.1 2.8 -- Russell 1000 Growth 22.59 S&P 500 Value 2.99S Sprint Nextel Corp. 0.6 2.8 $22.89 Returns Since Beginning of Year (1/1/2006): Russell 1000 Value 3.87

Utilities Sector 3.4 2.5 -- Lehman Brothers U.S. Equity Strategy Model Growth Portfolio 2.65 Data as of 1/31/2006EXC Exelon Corp. 0.3 2.5 $57.42 S&P 500 Growth 2.34

Russell 1000 Growth 1.76Returns Since Model Portfolio Inception (9/2/2003): Data as of 1/31/2006Lehman Brothers U.S. Equity Strategy Model Core Portfolio 41.64S&P 500 Index 30.72Returns Since Beginning of Year (1/1/2006):Lehman Brothers U.S. Equity Strategy Model Core Portfolio 4.26S&P 500 Index 2.66

Data as of 1/31/2006

Source: Lehman Brothers and FactSet

Past performance is not a guarantee of future results.

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GLOBAL EQUITY RESEARCH

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