Transcript Current State of the Economy (CFO)

New Opportunities:
Rediscovering
Purpose
Our privileges can be no greater than our
obligations. The protection of our rights can
endure no longer than the performance of our
responsibilities.
- John F. Kennedy
Introduction
Executive Summary
•
We seem to be in a Socialistic Phase of capitalism…similar to that of the 30’s or 70’s. Big Government to the rescue....we
believe this phase began at the turn of the century with the Dot Com bust, the subsequent uncovering of corporate
malfeasance, and the demand for greater oversight. The Property Bubble and subsequent Bank and Economic fallout
provided a platform to further the socialistic agenda.
•
The Global Financial System is recovering from a near meltdown scenario, and remains quite fragile. Government aid has
largely been repaid and banks are repairing their balance sheets. Future regulation is uncertain, but the Administration’s
regulatory focus bridges the gap between Glass Steagall and the fully integrated banks of today.
•
The FED acted as Lender of Last resort in the recent crisis and the key issue going forward is the removal of monetary
stimulus from the system. We believe this will begin with the gradual reduction of the FED’s balance sheet.
•
It appears that Fiscal Stimulus has succeeded in moving some growth into more recent quarters, however, it is difficult to
ascertain whether and long term benefit will result from the Government’s actions. Regardless, U.S. and Global economic
activity is accelerating and it would appear that the recovery began late in the 2nd quarter.
•
Due to the abundance of liquidity and the growing middle class of many emerging countries Global trade is rapidly
improving. It appears as though the expansion will continue throughout 2010, but the jobless rate is likely to remain high and
growth, particularly in the U.S., may be somewhat muted. This is primarily due to headwinds brought about by weak
constructions spending, real estate fall out, and a retruenching U.S. consumer.
•
The likely result of the massive amount of Fiscal and Monetary intervention is a weak dollar and rising inflation.
•
Ultimately, we believe that Capitalism will prove resurgent in the U.S. as our citizens realize that “Bigger” government is not
the ultimate solution and that the free enterprise system provides the best form of capital allocation.
Laying the Groundwork
2000-2007
• The Asset Bubble of the Late 90’s
• Consumer Led Recession of 2001
• Market Crash
– Leads to Asset Flow to Leverage
Real Estate Assets
• Slow “Jobless” Recovery
Laying the Groundwork
2000-2007
• Modest Economic Expansion
• Market Improvement
• Significant Corporate Profit Growth
• Low Volatility across all asset classes
– Declining Risk Premiums
– Increasing Leverage
Laying the Groundwork
2000-2007
• Synchronized Global Expansion
• Leveraged Real Estate Speculation
• Inflationary Pressure
• Commodity Boom
• Rising Interest Rates
– FED began raising interest rates in 25BPS increments in
June of ’04 and ended in June of ’06 at 5.25%
The Crisis Begins Early 2007
Credit Crunch
Weakening
RE Market
Defaults on
Subprime Mortgages
Credit Standards
Tighten
Questions Regarding CDO’s
(Collateralized Debt Obligations)
Performance
Plummets
Illiquidity led
to further Declines
Weak Performance
Investors
Begin Exit
Early Stages
Late 2007
• Rising Interest Rates Lead to Defaults and Initial
Liquidity Crisis in August of ’07
• Fed Reacts Strongly
• Market Rallies
• Corporate Profits Rise
• Global Expansion Continues
Early Stages
First Half 2008
• Defaults Mount and Mark to Market Accounting
begins to affect Bank Stocks
• Fed Intervenes in January with unscheduled cut of
75BPS
• Auction Rate Preferred Fiasco
• Bear Stearns “Run on the Bank” Treasury engineers
Takeover
• Market Rallies
Tipping Point
2nd Half 2008
• Fear Mounts regarding solvency of Global Banking
System and Mortgage Backed Securities
• FED and Treasury Intervene
• Fannie Mae & Freddie Mac
essentially nationalized
• AIG essentially nationalized
• Lehman Arbitrarily allowed to fail to avoid claims
surrounding “Moral Hazard”
Tipping Point
2nd Half 2008
• Bank Lending Freezes
– Global Liquidity dries up
• Crisis spills dramatically into Global Economy
• Stock Market Collapses
• FED, Treasury, and Congress Intervene
• All Major Investment Banking Firms Merge or
Become Bank Holding Companies
The Bottom Begins
Late 2008
• Global Economy in deep recession
• Global Banking community
extremely fragile
• Extreme Pessimism
• Stock Market Crash
The Bottoming Process
Liquidity Dries Up
The Impact of the Financial Sector Credit Crunch
The Bottoming Process
Hoarding
Banks Will not Lend – Confidence Must be Restored
The Financial Sector Update
• Winners:
– Goldman Sachs
– Morgan Stanley
– JP Morgan Chase
– Wells Fargo
– Bank of America
The Financial Sector Update
•
•
•
•
•
•
•
FDIC Insurance 250k through 2010
FED Three year corporate debt Backing
New Equity Issuance
New Debt Issuance
Steep Yield Curve
Massive Reserve Build – up
TARP Paydown
Government Intervention
– FDIC Temporary Liquidity Guarantee Program (guaranteeing newly issued senior unsecured debt of
banks, thrifts, and certain holding companies)
– FDIC expansion of deposit guarantee to $250K from $100K
– American Recovery and Reinvestment Act 2009 (tax cuts, spending programs)
– Making Home Affordable Program (refi for 5 million homeowners and $75 billion loan mod
program for those facing foreclosure)
– Capital Purchase Program (Treasury invests in preferred equity securities issued by qualified
financial institutions)
– Asset Guarantee Program for Citibank and BofA
– Public-Private Investment Program (Treasury/FDIC/Fed program to support legacy assets)
– Automotive Industry Financing Program (loans and equity investments for GM, GMAC, Chrysler,
and Chrysler Financial)
– Cash for Clunkers
– First-time homebuyers tax credit
The FED Intervention
FED
Balance
Sheet
2,273.7
Treasuries
776.6
Securities
Held
Outright\
1906.0
Term
Auction
Credit
75.9
Agencies
160.8
Agency
Mortgage
Backed
968.6
Other
Loans
84.8
Discount
Window
15.9
Primary
Dealer
Credit
Facility
ABCP
MMF
Liquidity
Facility
Commercial
Paper
Funding
Facility
14.1
Maiden
Lane
LLC
26.7
AIG
22.3
Term
AssetBacked
Securities
Lending
46.6
Maiden
Lane II
LLC
15.4
Maiden
Lane III
LLC
22.4
AIA
Aurora
ALICO
Holdings
LLC
25.1
Central
Bank
Liquidity
Swaps
5.9
Other
Federal
Assets
98.6
The Recovery
• Between 1854 and 2001
– 32 business cycles
• Averages
– Recession 17 month duration
– Expansion 38 month duration
– Cycle 55 month duration
» National Bureau of Economic Research
The Recovery
• Monetary Stimulus in full swing
• Quantitative Easing By the FED
• Central Bank Cooperation
• Fiscal Stimulus
The Recovery
The Recovery
The Recovery
• We believe the Recovery began late in the 2nd quarter.
• The ISM Index has been rising for nearly 12 months
• Global Manufacturing is improving
• Global Trade is improving
• Home Prices seem to have bottomed
The Recovery
• Consumer Confidence and Sentiment have improved
• Unemployment is bottoming out; we expect it to base
in the first quarter
• Inventory Rebuild is beginning
• Corporate Profits are improving
The Recovery
Indicator
THEN
1-08
NOW
1-09
POS/NEG
Industrial
Production
-5.1
0.8
Pos
ISM
32.9
55.9
Pos
Real Trade Deficit
-52.2
-38
Pos
Real GDP
-2.6
2.2
Pos
Consumer
Confidence
52.9
38.6
Pos
Real Consumer
Spending
0.8*
0.2
Neg
Non-Farm
Payrolls
-347
-85
Pos
Unemployment
Rate
7.4
10
Neg
The Recovery
Unemployment Rate 1948 – 2009
Current rate -10.0%
Highest Post WWII Rate 10.8% in 1982….Great Depression Unemployment approx 25%
The Recovery
Long Run GDP
The Recovery
US Population Growth Still Increasing – Echo Boomers on the way
The Recovery
Unemployment is generally a lagging indicator while Manufacturing is a leading
indicator of expansion
The Recovery
The Fed has a dual mandate of price stability and full employment: What do they
generally focus on?
The Recovery
• Most Likely Scenario
– Economy pulled out of recession in mid 2009 and the new
expansion has begun. Moderate growth with relatively
high unemployment should be expected for 2010.
• Negative Scenarios
– Central Banks unable to stabilize banking system, stimulus
fails and banks refuse to lend…Economic Decline and
Stagnation are likely result – Low Growth Potential
Deflation
– Central Bank activity coupled with Government stimulus
results in massive inflation, growth is choked out and asset
values eventually plummet when the system fails
Strategic Market Outlook
Summary
• Markets rallied dramatically off the March 9th Low
• The S&P 500 is up over 70% from its low and over 26% in 2009
• Due to a resumption of the decline in the dollar International Equities
outperformed domestic equities.
• Emerging Markets were up approximately 75% in 2009
• Treasury bonds performed poorly as investors moved to riskier assets
• Spreads Tightened - High Yield and Investment Grade Corporate bonds
rallied along with equities
Strategic Market Outlook
Summary
• Profits Rebounded in 3rd & 4th quarters of ‘09
• Corporate Balance sheets strong and Corporate Funding Gap remains
negative
• Extreme Growth Value Divergence
• REIT’s went from extremely undervalued to fairly valued, or perhaps
overvalued
• Hedge Fund Improvement
• Diversification proved beneficial
• Summary for 2009 – A rising tide lifts all boats
Strategic Market Outlook
Projections
Firm
Bank of America
Bank of Montreal
Barclays
Citigroup
Credit Suisse
Deutsche Bank
Goldman Sachs
JP Morgan
Morgan Stanley
Oppenheimer
RBC
UBS
Mean
Median
High
Low
Strategist
David Bianco
Ben Joyce
Barry Knapp
Tobias Levkovich
Andrew Garthwaite
Binky Chada
David Kostin
Thomas Lee
Jason Todd
Brian Belski
Myles Zyblock
Thomas Doerflinger
2010 Close
1275
1120
1150
1125
1260
1250
1300
1300
1200
1250
1223
1250
1300
1120
2010 EPS
73
71
66
72.5
76
77.8
76
80
70
70
72
80
$73.69
$72.75
$80.00
$66.00
Strategic Market Outlook
Valuation
• Corporate Profits are improving
• Earnings Expectations have been
sharply cut and do not seem to be
fully reflecting economic potential
• Market Prices are reasonable on a
forward looking basis
– P/E = 15
– P/B = 2.0 – 2.5
– Yield = 2%
Mistiming the Market Can Have
Serious Consequences
Investment Period
Fully Invested (20 years)
Average Annual Total Return
10.9%
Minus 5 Best Days
9.3%
Minus 15 Best Days
6.9%
Minus 25 Best Days
5.0%
Study Conducted: 6/30/1986 to 6/30/2006
Source: Ned Davis Research and Oppenheimer Funds 6/30/06
Average Investor Returns are Low
Annualized Returns – 1986 through 2007
16.0%
14.0%
11.3%
12.0%
10.0%
8.62%
8.0%
6.0%
4.54%
4.31%
4.0%
3.68%
2.0%
0.0%
Stocks
Bonds
Source: Dalbar QAIB 2007 Study, Ibbotson
Stocks=S&P 500, Bonds=Long-Term Government Bond Index
Inflation=Treasury Bills, Investor=Average Equity Fund Investor,
Inflation
Investors
Gold
Strategic Market Outlook
Econ Pro’s
• Economic Fundamentals improving
• ISM Manufacturing Moving Higher for nearly 12 months
• Global Manufacturing Indexes improving
• TARP Payback – Banking Improvement
• 4th Quarter GDP likely to be above 4%
• Recession Likely Ended late in 2nd quarter or early 3rd quarter
Strategic Market Outlook
Econ Con’s
• Consumer Retrenching
• “New Normal”
• Banking Fragility
• Weak Global Demand
• Trade War – Tariff Issues
• Monetary Stimulus – Quantitative Easing
• Deflation
Strategic Market Outlook
Econ Forecast
• Econ Probability
– Deflationary Meltdown < 20%
– Slow Growth Expansion 40-50%
– Inflationary Bust/Stagflation > 30%
Strategic Market Outlook
Portfolio Impact
•
Favor Stocks relative to Bonds
•
∆ Retain REIT exposure at Target Levels
•
∆ High Yield Bonds Particularly Attractive
•
Overweight Large Cap
•
∆ Overweight International Exposure
•
Favor Growth to Value across all asset classes
•
∆ Hold Emerging Markets Exposure at target
levels
•
∆ Cash yields to remain low – favor short
duration, high grade, corporate bond
exposure .
•
Retain Small Cap Exposure at Target Weight
•
Begin Reviewing TIPS as fixed income
alternative and/or cash alternative
•
Commodity Trading accounts remain
attractive
•
Hedge Funds Retain at Target Weight
Disclosures
Financial Advisory Consultants DBA/Cornerstone Management Inc. is a
Registered Investment Advisory Firm. Although the information in this report
has been obtained from sources that the Firm believes to be reliable, we do not
guarantee its accuracy, and any such information may be incomplete or
condensed. All opinions included in this report constitute the Firm’s judgment
as of the date of this report and are subject to change without notice. This
report is for informational purposes only and is not intended as an offer or
solicitation with respect to the purchase or sale of any security.
This presentation may only be dispensed with the disclosure page attached.