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The Economic Outlook: Growth Rotates David Wyss Chief Economist Standard & Poor’s November 2006 CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Copyright (c) 2006 Standard & Poor’s, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved. The U.S. Recovery Is Slowing • After a strong 2004 and 2005 • Growth has slowed to below trend. • The economy is rotating from consumer- and housing-led growth to investment-led growth. • The Fed is through hiking interest rates, and will probably have to reverse next year. • The housing market peaked last summer, but is more stalling than plunging. Starts are expected to drop 25%. • Oil prices are coming down from record highs, restoring some purchasing power. • Katrina rebuilding has been slow. • Stronger European growth and a weaker dollar should mean less drag from the trade deficit. CONFIDENTIAL AND PROPRIETARY. 2. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Oil Prices Hit New Highs ($/barrel, WTI and deflated by CPI; household energy purchases as percent of disposable income) 90 80 70 60 50 40 30 20 10 0 1980 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 1985 Oil price (WTI) 1990 1995 2005 dollars 2000 % of disp. income (right) Source: BEA CONFIDENTIAL AND PROPRIETARY. 3. 2005 Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. The World Is More Energy Efficient (Tonnes of oil equivalent per $1000 dollars (2000 dollars) of real GDP) 1 0.8 0.6 0.4 0.2 0 US France Germany UK 1971 1980 Japan China 1995 Source: OECD CONFIDENTIAL AND PROPRIETARY. 4. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. India World 2004 The Fed Is Moving Toward Neutral (Percent) 10 8 6 4 2 0 1995 1997 1999 2001 Federal Funds Rate 2003 2005 2007 10-Yr Bond Yield Source: Federal Reserve CONFIDENTIAL AND PROPRIETARY. 7. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2009 Mortgage rate Interest Rates Had Converged (Long-term government bonds) 6 5 4 3 2 1 0 US Canada Japan Oct-04 Euro Dec-05 UK Oct-06 Source: Bloomberg CONFIDENTIAL AND PROPRIETARY. 8. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Australia Quality Spreads Grind Tighter (Spread over Treasury yields, basis points) 900 800 700 600 500 400 300 200 100 0 2003 2004 Investment grade 2005 2006 Speculative grade Source: S&P CONFIDENTIAL AND PROPRIETARY. 9. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Financial Risk Is Greater 100% 80% 60% 40% 20% 0% 1980 1985 AAA AA 1990 A 1995 BBB 2000 Junk Source: S&P CONFIDENTIAL AND PROPRIETARY. 10. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2004 World Growth Is Steady (Real GDP, % change) 8 6 4 2 0 US 2003 Canada Eurozone 2004 2005 Japan 2006 Other Asia 2007 Source: Global Insight and S&P CONFIDENTIAL AND PROPRIETARY. 11. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Latin America 2008 And Comes Mostly From Asia (IMF purchasing power weights, 2005) Other 19% Other 19% US 21% US 15% Eurozone 4% East Eur 7% Japan 4% East Eur 9% Other Adv 8% Eurozone 15% India 6% India 10% China 15% Japan 6% China 31% Other Adv 11% Percent of World GDP Percent of World Growth Source: IMF CONFIDENTIAL AND PROPRIETARY. 12. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Fiscal Deficits Almost Everywhere (Government balance as percent of GDP, 2004) 3 2 1 0 -1 -2 -3 -4 US Canada France Germ. Italy Source: IMF CONFIDENTIAL AND PROPRIETARY. 14. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. UK The Future Looks Bleak (Government debt as % of GDP) 600 530 500 350 400 300 200 100 113 173 101 49 223 182 38 62 57 86 220 59 71 0 US Japan 2005 UK France 2025 Source: S&P CONFIDENTIAL AND PROPRIETARY. 15. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Germany 2050 Aging Populations Will Boost Government Spending (Ratio of over 65 population to labor force) 60 50 40 30 20 10 0 US Canada France Germany Italy UK Japan AustraliaMexico OECD 2000 Source: OECD CONFIDENTIAL AND PROPRIETARY. 16. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2020 US Trade Deficit Balances Surpluses Overseas (Trade balance as percent of GDP, 2005) 6 4 2 0 -2 -4 -6 -8 US Canada Germany France Italy UK Japan Source: Global Insight CONFIDENTIAL AND PROPRIETARY. 17. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. China India US Borrows From Abroad to Offset Weak Savings (Percent of GDP) 22% 20% 18% 16% 14% 12% 10% 8% 1970 1975 1980 Gross saving 1985 1990 1995 Private saving 2000 Private investment Source: BEA CONFIDENTIAL AND PROPRIETARY. 18. 2005 Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. European Productivity Growth Trails (Output per hour, percent change, 1995-2005) 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Eurozone UK Japan Source: BLS CONFIDENTIAL AND PROPRIETARY. 19. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. US Other Countries Are Catching Up (Percentage of tertiary degrees by age group, 2003) 45-54 25-34 60 50 40 30 20 10 0 C ad an a e c an r F e G an m r y Ita ly pa Ja n K ea r o i ex M co Source: OECD CONFIDENTIAL AND PROPRIETARY. 20. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. U K U S Educated Workers Earn More (Ratio of income of tertiary graduate to high school graduate, men 30-44) Source: OECD CONFIDENTIAL AND PROPRIETARY. 21. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. U .S . . U .K or ea K ly It a an y G er m ce Fr an ad a C an A us tr al ia 190 180 170 160 150 140 130 120 110 100 Can the Consumer Keep Spending? • Consumer spending has led the expansion • The tax cuts provided extra income • Lower mortgage rates freed up funds • Confidence is up • But the saving rate is negative • Tax cuts are over • Interest rates are up • Home prices are dropping • Net result will be a slowdown, not a retreat • Helped by lower energy prices • The saving rate will remain low CONFIDENTIAL AND PROPRIETARY. 22. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. But Wealth Continues Strong, Helped By Housing Markets (Percent of after-tax income) 700% 600% 500% 400% 300% 200% 100% 0% 1990 1993 1996 1999 Net worth 2002 2005 2008 Financial assets Source; Federal Reserve CONFIDENTIAL AND PROPRIETARY. 23. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Debt Service Now Above 1986 Record (Household obligations as percent of after-tax income) 22 20 18 16 14 12 10 8 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 Financial Obligations Source: Federal Reserve CONFIDENTIAL AND PROPRIETARY. 24. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Debt Debt Repayments Are Evenly Distributed (Average debt repayment as percent of income by income percentile) 20 16 12 8 4 0 0-20 20-40 1995 40-60 60-80 80-90 2004 Source: SCF CONFIDENTIAL AND PROPRIETARY. 25. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 90-100 Household Debt By Country (Percent of income, 2005) Canada France Germany Italy Japan UK US 0% 50% 100% Source: IMF CONFIDENTIAL AND PROPRIETARY. 26. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 150% US Is Actually Low-Debt (Assets as percent of GDP, 2004) EU Japan US 0 100 Private debt 200 300 Bank loans 400 Govt debt Source: IMF CONFIDENTIAL AND PROPRIETARY. 27. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 500 Equity A Housing Bubble? • Housing remains affordable • Thanks to low mortgage rates • But what happens when rates go up? • Home prices have outpaced incomes • Ratio of home price to income is at a record high • There are big local bubbles – E.g., New York, California, Boston, Florida • And higher mortgage rates will cause starts and sales to drop • Housing looks less overvalued than other assets CONFIDENTIAL AND PROPRIETARY. 28. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Home Prices Are High Relative to Household Income (Ratio of average home price to average household disposable income) 4.5 4 3.5 3 2.5 2 1975 1979 1983 Existing 1987 1991 New 1995 1999 2007 Quality-adjusted Source: BEA CONFIDENTIAL AND PROPRIETARY. 29. 2003 Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Bubbles Are Everywhere (Percent increase in home prices, 1997-2005) US Canada Germany Switzerland Netherland Britain Ireland Italy Sweden France Spain Japan Australia China NewZealan Hong Kong -100 -50 0 50 100 Source: The Economist and S&P CONFIDENTIAL AND PROPRIETARY. 30. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 150 200 250 The Stock Market Will Recover, But Slowly • Market rose over 20%/year from 1995 -99 • But dropped from March 2000 through June 2003 • Biggest drop since 1929-32 • Double-digit earning gains for a record 17 quarters; profits are a record high relative to GDP • Earnings must slow • Share prices cannot continue to outpace earnings • As interest rates rise • Stocks will thus yield less in the future than in the recent past. • But the current rally is being spurred by strong earnings and dividend tax cuts CONFIDENTIAL AND PROPRIETARY. 31. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Largest Stock Markets Remain Below 2000 Peaks (Change in S&P stock indexes since March 2000 peak) Australia (50) Asia/Pacific (50) Japan (150) Europe (350) Lat Am (40) Canada (60) US (500) World (1200) -60 -30 0 Oct-02 30 60 90 Sep-06 Source: S&P CONFIDENTIAL AND PROPRIETARY. 32. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 120 150 Most US Sectors Have Recovered From The Bear Market (Change in S&P 500 sectors since March 24, 2000 peak) Utilities Telecomm Materials Technology Industrials Health Care Financials Energy Cons Staples Cons Discr S&P 500 -100 -75 -50 Oct-02 -25 0 25 50 Sep-06 Source: S&P CONFIDENTIAL AND PROPRIETARY. 33. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 75 100 Economic Updates • Thank you for your attention • If you would like to receive our regular economic and credit market updates, please register at: • http://www.standardandpoors.com/gfir/register CONFIDENTIAL AND PROPRIETARY. 34. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Analytic services and products provided by Standard & Poor’s are the result of separate activities designed to preserve the independence and objectivity of each analytic process. Standard & Poor’s has established policies and procedures to maintain the confidentiality of non-public information received CONFIDENTIAL AND PROPRIETARY. during each analytic process. 35. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s.