Transcript The Economy and Financial Markets

The Economy and Financial Markets
February 22, 2008
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The Economy and Financial Markets
Economy and Financial Markets:
Current Conditions
 Economy strong in Q3, slow in Q4 and Q1.
 Inflation contained – core around 2-2.5%.
 Profits / Earnings big short-term hit – sub prime related.
 Stock price gains in 08 expected to match earnings growth.
 Risks are: terrorism, Iraq, oil prices and subprime reaction.
 Bond market risk moderate due to good inflation outlook.
 Credit market concerns appear overblown, damage limited.
 $ exchange rate bouncing off a new record low.
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The Economy and Financial Markets
Q3 GDP Up 4.9%, Q4 +0.6% (Lower Due to Housing
& Inventory Drop), Employment Growth +0.7%
Quarterly % Change in Real GDP
% Change - Annual Rate
12-Month % Change in Payroll Employment
% Change - Year to Year
12
12
8
8
4
4
0
0
-4
-4
-8
-8
85
90
Sources: BEA, BLS /Haver
95
00
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The Economy and Financial Markets
ECRI and Dow Barometer Down, Expect Slowdown,
Not Recession
ECRI Weekly Leading Index
1992=100
Dow Jones U. S. Business Barometer Index
2000=100
160
104
100
140
96
120
92
88
100
84
80
80
90
95
Sources: ECRI, BTMU /Haver
00
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The Economy and Financial Markets
Real Personal Income Rising, as is Spending:
Not Much Housing Impact
Real After-Tax Personal Income
SAAR, Bil. Chn. 2000$
Real Personal Consumption Expenditures
SAAR, Bil. Chn. 2000$
9000
9000
8250
8250
7500
7500
6750
6750
6000
6000
5250
5250
4500
4500
90
95
00
05
Source: Bureau of Economic Analysis /Haver Analytics
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The Economy and Financial Markets
New Orders Surge But Shipments Still Flat –
Business Cost Control
Shipments of Manufacturing Durable Goods
SA, Mil. $
New Orders for Manufacturing Durable Goods
SA, Mil. $
250000
250000
225000
225000
200000
200000
175000
175000
150000
150000
125000
125000
100000
100000
90
95
00
Source: Census Bureau /Haver Analytics
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The Economy and Financial Markets
Order Backlog Very High, Inventories
Low Relative to Shipments
Unfilled Orders for Durable Goods: Order Backlog Very High
SA, Mil. $
Ratio of Inventories to Shipments: Low - No Inventory Overhang
Ratio
825000
2. 4
750000
2. 2
675000
2. 0
600000
1. 8
525000
1. 6
450000
1. 4
375000
1. 2
90
95
Source: Haver Analytics
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The Economy and Financial Markets
Home Prices Weak, Income Up So Housing “P / E” Now
Way Down (Especially Given Low Interest Rates)
Median Sales Price: Existing 1-Family Homes
$
Ratio: Median Price / Disposable Income per Capita
Measure of housing P/E
240000
8. 0
200000
7. 5
160000
7. 0
120000
6. 5
80000
6. 0
40000
5. 5
0
5. 0
70
75
80
Source: Haver Analytics
85
90
95
00
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The Economy and Financial Markets
Home Sales and Starts Now Way Down – After 2 Years of
Decline, The Worst Likely Behind Us.
Housing Starts
SAAR, Thous. Units
New Single Family Home Sales
SAAR, Thous
2400
1400
2000
1200
1600
1000
1200
800
800
600
400
400
90
95
00
Source: Census Bureau /Haver Analytics
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The Economy and Financial Markets
Major Credit Threat? No – Total Bank Problem Loans Low. Q4 Residential Loan
Delinquency 3.1%, Defaults 0.4%, Low, But Likely to Rise
Loan Delinquency Rate: All Commercial Banks
SA,%
Loan Charge-Off Rate: All Commercial Banks
SA,%
7
7
6
6
5
5
4
4
3
3
2
2
1
1
0
0
85
90
95
00
Source: Federal Reserve Board /Haver Analytics
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The Economy and Financial Markets
US Trade Upturn Offsets Housing Weakness. U.S. Exports Are
Three Times As Big As Residential Construction.
Growth in Real U. S. Exports
% Change - Year to Year
Growth in Real U. S. Imports
% Change - Year to Year
20
20
10
10
0
0
-10
-10
-20
-20
94 95 96 97 98 99 00 01 02 03 04
Source: Bureau of the Census /Haver Analytics
05
06
07
08
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The Economy and Financial Markets
Claims Lead Unemployment Rate (4.9%), Claims Are
Up Some, So Unemployment May Drift a Bit Higher.
Unemployment Rate
SA, %
Weekly Initial Claims for Unemployment Insurance
SA, Thous
8. 25
600
7. 50
525
6. 75
450
6. 00
375
5. 25
300
4. 50
3. 75
225
90
95
Sources: BLS, DOL /Haver
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The Economy and Financial Markets
Private Sector Employment Cost Inflation at 3% Benefit Costs Under Control
Change in Total Employment Cost Index (Wages + Benefits)
Private Sector: 4-Quarter % Change
Change in Benefits Cost - Has Slowed Considerably
4-Quarter % Change
8
8
7
7
6
6
5
5
4
4
3
3
2
2
1
1
90
95
00
Source: Bureau of Labor Statistics /Haver Analytics
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The Economy and Financial Markets
Total CPI Inflation Up Due to Oil Prices,
Core Still Down at 2.4%
Total CPI Inflation
% Change - Year to Year
Core CPI Inflation (Excludes Food & Energy
% Change - Year to Year
7
7
6
6
5
5
4
4
3
3
2
2
1
1
90
95
00
Source: Bureau of Labor Statistics /Haver Analytics
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The Economy and Financial Markets
Fed Target is (Roughly) Core Inflation + Employment
Growth. We Think Rate Cuts are the Right Policy Action
Fed Funds Target Rate
EOP, %
Sum of Core CPI Inflation and Payroll Employment Growth
%
10
8
10
Fed funds rate finally below the 3.2% sum of core CPI
inflation of 2.5% and job growth of 0.7%.
8
6
6
4
4
2
2
Fed over did it in late 1999 - 2000
0
0
90
95
Source: Haver Analytics
00
05
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The Economy and Financial Markets
Risks? Sure – Sky High Oil Prices &
Lack of Dollar Rebound
Crude Oil Price - West Texas
EOP, $/Barrel
Dollar Exchange Rate - Major Currency Index
Avg, 3/73=100
120
100
112. 5
Record oil price behind us?
105. 0
80
97. 5
60
90. 0
40
82. 5
20
75. 0
0
Record Dollar lows behind us?
90
95
Sources: WSJ, FRB /Haver
00
67. 5
05
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The Economy and Financial Markets
Company Earnings Outside Financials Okay, but Big Q3-Q4 Hit on
Financials From the Sub-Prime Fiasco.
S&P 500: After-tax Earnings with Next Quarter Estimate
$/Shr
S&P 500: Operating Earnings with Next Qtr Estimate
$/Share
24
28
20
24
16
20
12
16
8
12
4
8
0
4
90
95
00
Source: Standard & Poor's /Haver Analytics
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The Economy and Financial Markets
Current Quarter S&P 500 P / E is around 22 – Spike Due to Subprime Hit
Higher Risk on the Value Side, Lower Risk on the Growth Side
P/E Ratio: S&P 500 Stock Price Divided By Same Quarters Earnings
P/E calculated using current quarter operating earnings times 4
0. 35
0. 35
Higher Risk Region
0. 30
0. 30
0. 25
0. 25
0. 20
0. 20
0. 15
0. 15
Lower Risk Region
0. 10
0. 10
90
95
Source: Haver Analytics
00
05
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The Economy and Financial Markets
Record U.S. Net Stock Repurchases $610 Billion Last Four Quarters
US Net New Equity Issues: Record High Stock Buybacks!
New Equity Issued less Stock Bought Back in $Billions at Annual Rates
200
200
0
0
-200
-200
-400
-400
-600
-600
-800
-800
50
55
60
65
70
Source: Haver Analytics
75
80
85
90
95
00
05
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The Economy and Financial Markets
Corp. Balance Sheet – Companies’ Financial Assets Exceed Liabilities
by $1.4 Trillion. Now Net Lenders, Usually are Net Borrowers
Financial Assets Less Liabilities of All US Nonfinancial Corps.
billions - US companies are now net lenders
1500
1500
Total U.S. non-financial companies net lenders
1000
1000
500
500
0
0
-500
-500
-1000
-1000
Total U.S. non-financial companies net borrowers
-1500
-1500
55
60
65
70
Source: Haver Analytics
75
80
85
90
95
00
05
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The Economy and Financial Markets
Equity Total Return Beats Fixed Income,
with Volatility
but
S&P 500 Total Return
EOM
Lehman Bond Index: US Aggregate Total Return
EOP, Dec-31-75=100
2500
2500
2000
2000
1500
1500
1000
1000
500
500
0
0
90
95
00
Sources: Standard & Poor's, Lehman Brothers/ Haver Analytics
05
02/22/08
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The Economy and Financial Markets
Value Has Outperformed Growth Since 2000 –
is Now Reversing
Total Return: Russell 3000 Value Index
5/31/95=1000
Total Return: Russell 3000 Growth Index
5/31/95=1000
4500
4500
3750
3750
3000
3000
2250
2250
1500
1500
750
750
95 96 97 98 99 00 01 02 03 04 05
Source: Frank Russell Company /Haver Analytics
06
07
08
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The Economy and Financial Markets
About 110% Outperformance of Value Since 2000
Now Reversing
Cumulative Total Return of Value Relative to Growth
Ratio: Russell 3000 Value / Growth Total Return Indices
1. 8
1. 8
1. 6
1. 6
1. 4
1. 4
1. 2
1. 2
1. 0
1. 0
0. 8
0. 8
0. 6
0. 6
80
85
Source: Haver Analytics
90
95
00
05
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The Economy and Financial Markets
Small Caps Outperformed Large Caps
Since 1999 – Now Reversing
Total Return: Russell 1000 Large Cap Index
Avg, 12/31/78=100
Total Return: Russell 2000 Small Cap Index
Avg, 12/31/78=100
4500
4500
3750
3750
3000
3000
2250
2250
1500
1500
750
750
94 95 96 97 98 99 00 01 02 03 04
Source: Frank Russell Company /Haver Analytics
05
06
07
08
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The Economy and Financial Markets
Last 28 Years Small Caps have NOT Outperformed
Large Caps. Back to Underperforming
Cumulative Total Return of Small Relative to Large Caps
Ratio: Russell 2000 / Russell 1000 Total Return Indices
1. 6
1. 6
1. 4
1. 4
1. 2
1. 2
1. 0
1. 0
0. 8
0. 8
0. 6
0. 6
0. 4
0. 4
80
85
Source: Haver Analytics
90
95
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The Economy and Financial Markets
Large Cap International Equities (EAFE Index) Now
Underperforming The U.S.
EAFE Total Return Index in Dollars
EOP US$
S&P 500 Total Return
EOP
8000
8000
6000
6000
4000
4000
2000
2000
0
0
80
85
90
95
00
Sources: MSCI Inc. , Standard & Poor's /Haver Analytics
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The Economy and Financial Markets
Fast, Deep Short-term Rate Cuts Sharply Lower
Recession Probability. Low Long-term Rates Help.
30-Year Treasury Bond Yield
Avg,%
2-Year Treasury Note Yield
Avg, %
10
10
8
8
6
6
4
4
2
2
0
0
90
95
00
Sources: Haver Analytics, U. S. Treasury
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The Economy and Financial Markets
High Yield – Spreads Up On Sub Prime Worries
High Yield Rate
Source: Merrill Lynch
Yield Spread: High Yield Rate Less 5-Year Treasury Rate
%
15. 0
15. 0
12. 5
12. 5
10. 0
10. 0
7. 5
7. 5
5. 0
5. 0
2. 5
2. 5
0. 0
0. 0
96
97
98
99
00
Source: Haver Analytics
01
02
03
04
05
06
07
08
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The Economy and Financial Markets
Shark Chart: Return of Value & Growth
Relative to Total Market
Ratio: Russell 3000 Value to Russell 3000 Total Return Indices
Measures cumulative total return of Value relative to the Total market
Ratio: Russell 3000 Growth to Russell 3000 Total Return Indices
Measures cumulative total return of Growth relative to the Total market
1. 3
1. 3
1. 2
1. 2
1. 1
1. 1
1. 0
1. 0
0. 9
0. 9
0. 8
0. 8
0. 7
0. 7
80
85
Source: Haver Analytics
90
95
00
05
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The Economy and Financial Markets
Conclusions
 GDP growth for 08 expected to be in the 2% range.
 $80+ oil knocks 1-2%+ off GDP & cut jobs gain by a million.
 Total inflation up on oil prices, but core inflation remains low.
 Earnings are generally okay – expect 5-10% in 2008.
 S&P 500 P/E spiking up, but expect prices to track 08 earnings.
 Non-Financial Co. Earnings and Balance Sheet quality look high.
 Bond risk moderate, subprime problems concentrated.
 Dollar exchange rate risk now low (recovering from record low).
 Further fed funds rate cut to 2.5% likely.
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The Economy and Financial Markets
Important Disclosures
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in
the aggregate market value of 500 stocks representing all major industries.
The Russell 1000 Index measures performance of 1000 large cap, US companies. The Russell 2000 Index measures performance of 2000 small cap, US companies.
The Russell 3000 Growth and Value Indices measure the performance of growth and value stocks respectively.
The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries, and widely held by individuals and institutional investors. These 30
stocks represent about a fifth of the $8 trillion-plus market value of all U.S. stocks and about a fourth of the value of stocks listed on the New York Stock Exchange. It is not
possible to invest directly in an index.
The Lehman Brothers Aggregate Bond Index is composed of securities from the Lehman Government/Credit Bond Index, Mortgage Backed Securities Index and Asset
Backed Securities Index.
The Merrill Lynch High Yield Index is an unmanaged index consisting of bonds that are issued in U.S. Domestic markets with at least one year remaining maturity. All
bonds must have a credit rating below investment grade but not in default.
Government bonds and Treasury Bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of
return and fixed principal value.
High yield/junk bonds are not investment grade securities, involve substantial risks and generally should be part of the diversified portfolio of sophisticated investors.
Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the
value of these investments.
P/E Multiple: A tool for comparing the prices of different common stocks by assessing how much the market is willing to pay a share of each corporation’s earnings. It is
calculated by dividing the current market price of a stock by the earnings per share.
Past performance is no guarantee of future results. Indices such as the S&P 500 may not be invested into directly.
The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or
recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing.
The Morgan Stanley Capital International (“MSCI”) Europe, Australasia, Far East Index (“EAFE”) is an unmanaged index of over 900 companies, and is a generally
accepted benchmark for major overseas markets. Index weightings represent the relative capitalizations of the major overseas makers included in the index on a U.S.
dollar adjusted basis. The index is calculated separately; without dividends, with gross dividends reinvested and estimated tax withheld, and with gross dividends
reinvested, in both U.S. Dollars and local currency.
This research material has been prepared by LPL Financial.
The LPL Financial family of affiliated companies includes LPL, UVEST Financial Services Group, Inc., IFMG
Securities, Inc., Mutual Service Corporation, Waterstone Financial Group, Inc., and Associated Securities Corp., each
of which is a member of FINRA/SIPC.
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May Lose Value
Guaranteed
Not Guaranteed by any Government Agency
Not a Bank/Credit Union Deposit
Not FDIC/NCUA Insured
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Tracking# 396827 (Exp 12/08)
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