Transcript The Economy and Financial Markets November 15, 2007

The Economy and Financial
Markets
November 15, 2007
Economy and Financial Markets:
Current Conditions
• Economy still strong in Q3, real GDP up 3.9%.
• Inflation contained – core falling to, or below, 2%.
• Profits / Earnings one time hit likely in Q3 – sub prime related.
• Stock price gains expected to match earnings growth.
• Risks are the same – terrorism, Iraq, oil prices.
• Bond market risk moderate due to good inflation outlook.
• Credit market concerns appear overblown, damage limited.
• $ exchange rate bouncing off a new record low.
GDP Growth: Q3 GDP Up 3.9%, Employment Growth +1.2%
Quarterly % Change in Real GDP
% Change - Annual Rate
12-Month % Change in Payroll Employment
% Change - Year to Year
8
8
6
6
4
4
2
2
0
0
-2
-2
-4
-4
90
95
Sources: BEA, BLS /Haver
00
05
1 1 /1 5 /0 7
ECRI & Dow Barometer Both 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
100
88
80
84
90
95
Sources: ECRI, BTMU /Haver
00
05
1 1 /1 5 /0 7
Real Personal Income Rising, Chain Store Sales Soften.
ICSC-UBS Weekly Retail Chain Store Sales
SA, 1977=100
Real Disposable Personal Income
SAAR, Bil. Chn. 2000$
500
9000
450
8000
400
350
7000
300
6000
250
200
5000
90
95
Sources: ICSCUBSW, BEA /Haver
00
05
1 1 /1 5 /0 7
New Orders & Shipments Flatten – Business Spending Okay
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
05
1 1 /1 5 /0 7
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 Backlog
NMIDG / NMSDG
800000
2. 75
2. 50
700000
2. 25
600000
2. 00
1. 75
500000
1. 50
400000
1. 25
80
85
90
Source: Haver Analytics
95
00
05
1 1 /1 5 /0 7
Home Prices Weak, Income Up, Housing “P / E” Now Way Down
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
05
1 1 /1 5 /0 7
However, New Home Sales and Starts Continue to Plunge
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
05
1 1 /1 5 /0 7
Major Credit Threat? No – Total Bank Problem Loans Remain Low
Residential Loan Delinquency 2.3%, Defaults 0.2%, 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
05
1 1 /1 5 /0 7
US Trade Upturn Offsets Housing Weakness. Exports Now Rising Four
Times as Fast as Imports (13% vs. 3%)
US Export Growth
12-Month Percent Change
US Import Growth
12-Month Percent Change
30
30
20
20
10
10
0
0
-10
-10
-20
-20
97
98
99
00
01
02
03
Source: Census Bureau /Haver Analytics
04
05
06
07
1 1 /1 5 /0 7
Claims Lead Unemployment Rate – Steady Indicating Okay Labor Mkt.
Weekly Initial Claims for Unemployment Insurance
SA, Thous
Unemployment Rate
SA, %
600
8. 25
7. 50
525
6. 75
450
6. 00
375
5. 25
300
4. 50
225
3. 75
90
95
Sources: DOL, BLS /Haver
00
05
1 1 /1 5 /0 7
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
05
1 1 /1 5 /0 7
Total CPI Inflation Up Due To Oil Prices, Core Still Down at 2.2%
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
05
1 1 /1 5 /0 7
Fed Target Is (Roughly) Core Inflation + Employment Growth. We
Think The Recent Cut to 4.5% Was The Right Policy Action.
Fed Funds Target Rate
EOP, %
Sum of Core CPI Inflation and Payroll Employment Growth
%
10
8
10
4.5% fed funds rate still well above 3.4% sum of
core CPI inflation of 2.2% and job growth of 1.2%.
8
6
6
4
4
2
2
Fed over did it in late 1999 - 2000
0
0
90
95
Source: Haver Analytics
00
05
1 1 /1 5 /0 7
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
100
112. 5
Record oil price behind us? Nope.
105. 0
80
97. 5
60
90. 0
40
82. 5
20
75. 0
Record Dollar lows behind us? Nope.
0
67. 5
90
95
Sources: WSJ, FRB /Haver
00
05
1 1 /1 5 /0 7
Company Earnings Outside Financials Strong, But Big Q3 Hit From Sub
Primes. “Concensus Forecast” Expects Q3 Hit Then Q4 Rebound
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
05
1 1 /1 5 /0 7
Current Quarter S&P 500 P / E is around 17 – Looks Reasonable 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. 30
0. 35
Higher Risk Region
0. 30
0. 25
0. 25
0. 20
0. 20
0. 15
0. 15
Lower Risk Region
0. 10
0. 10
90
Source: Haver Analytics
95
00
05
1 1 /1 5 /0 7
Record U.S. Net Stock Repurchases - $590 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
1 1 /1 5 /0 7
Corp. Balance Sheet – Companies’ Financial Assets Exceed Liabilities by
$1.3 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
1000
1500
Total US non-financial companies net lenders
500
500
0
0
-500
-1000
1000
-500
Total US non-financial companies net borrowers
-1000
-1500
-1500
55
60
65
70
Source: Haver Analytics
75
80
85
90
95
00
05
1 1 /1 5 /0 7
Equity Total Return Beats Fixed Income, But With Volatility
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
11/15/07
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
1 1 /1 5 /0 7
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
1 1 /1 5 /0 7
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
1 1 /1 5 /0 7
Last 28 Years Small Caps Have NOT Outperformed Large Caps
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
00
05
1 1 /1 5 /0 7
Long Rates Stable, Short Rates Down, Another Fed Rate Cut? Maybe.
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
05
1 1 /1 5 /0 7
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
1 1 /1 5 /0 7
Shark Chart: Return of Value & Growth Relative to Total Mkt.
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
1 1 /1 5 /0 7
Conclusions
• GDP growth for 07 would be 4% if oil was in $35 range.
• $80+ oil knocks 1%+ off GDP & cut jobs gain by 800,000.
• Total inflation up on oil prices, but core inflation remains low.
• Earnings are generally okay – expect about 10% 2007 Q4/Q4.
• S&P 500 P/E at 17 – low enough for prices to track earnings.
• Earnings and Balance Sheet quality look high.
• Bond risk moderate, subprime problems not likely to spread.
• Dollar exchange rate risk now low (down at new record low).
• Fed funds rate cut to 4.5% on Oct. 1. Uncertain on future cuts.
Required 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.