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The Economic Outlook: Fasten Your Seatbelts David Wyss Chief Economist Standard & Poor’s September 4, 2008 CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Copyright (c) 2008 Standard & Poor’s, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved. The U.S. Is In Recession • The economy has moved into recession. • Housing has been in recession for two years, subtracting over a percentage point from GDP growth in 2007. • But that was offset by strength in nonresidential construction and the closing of the trade gap, each of which added back over a half point. • Weaker overseas growth will mean less benefit from the trade deficit, despite the declining dollar. • Nonresidential construction is beginning to decline • The fiscal stimulus package will cause the fiscal 2008 deficit to more than double, and could beat the 2004 record. But it should boost the economy late this year. • The Fed has cut rates sharply. • The recession should be mild because of the fiscal and monetary stimulus • But probably long. • And a deeper recession is possible if the financial markets remain locked up, oil prices continue to rise, and home prices continue to drop. CONFIDENTIAL AND PROPRIETARY. 2. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. The Housing Bubble • Housing was too affordable, thanks to low mortgage rates • But what happened when rates went up? • Ratio of home price to income hit a record high in 2006, • Which could not be maintained at higher interest rates • We built too many houses at too high prices • Starts and sales have dropped sharply • Defaults and foreclosures have soared, cutting back on willingness to lend • Prices are down 15% from their peak • We expect to hit bottom on starts this summer • But prices probably won’t hit bottom until early 2009. CONFIDENTIAL AND PROPRIETARY. 3. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Home Prices Were Too High (Ratio of average home price to average household disposable income) 4.5 4 3.5 3 2.5 2 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 Existing New Quality-adjusted Source: BEA, Census CONFIDENTIAL AND PROPRIETARY. 4. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Bubbles Were Almost 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: Mortgage Bankers’ Association and S&P CONFIDENTIAL AND PROPRIETARY. 5. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 150 200 250 Most Weakness Is In The Bubble Cities (S&P/Case-Shiller Home Price Indexes) Top 5 Charlotte Dallas Denver Portland, OR Seattle 2002-2005 Price/income May-08 average ratio (2005) (12-month percent change) -0.2 4.1 3.8 -3.1 2.7 3.0 -4.8 2.6 4.5 -5.2 13.1 5.0 -6.3 12.2 7.1 20-City Average -15.8 14.3 6.3 Bottom 5 Las Vegas Miami Phoenix Los Angeles San Diego -28.4 -28.3 -26.5 -24.5 -23.2 17.5 19.9 20.6 15.8 17.2 6.1 8.6 5.1 13.4 14.0 Detroit -17.4 3.1 2.6 Source: Standard & Poor’s, Census Bureau CONFIDENTIAL AND PROPRIETARY. 6. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Home Price Declines (1-year change in home prices, First quarter) +3% or more 0% to +3% 0% to -3% -3% or worse Source: OFHEO CONFIDENTIAL AND PROPRIETARY. 7. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. The Fed Is Done Cutting (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. 8. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2009 2011 Mortgage rate Foreign Money Is Coming Into Private Bonds (Net inflows of long-term capital, Millions of dollars) 1400000 1200000 1000000 800000 600000 400000 200000 0 2001 2002 2003 2004 2005 2006 2007 Treasury Agency Private Source: US Treasury. CONFIDENTIAL AND PROPRIETARY. 9. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Equity Quality Spreads Are Widening From Record Lows (Spread over Treasury yields, percentage points) 12 10 8 6 4 2 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 Default rate (12-month) Old spread series Credit spread Source: Standard & Poor’s Global Fixed Income Research CONFIDENTIAL AND PROPRIETARY. 10. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. The World Is Ignoring The U.S. Sniffles • World growth remains solid • Slower growth in the US and Europe is offset by stronger growth in Asia • The train has more engines attached • And the world is thus less dependent on US growth • We expect a slight slowdown in world growth, to 4.2% from 5.4% in 2007 • But the big trade and capital imbalances are a risk • And higher oil prices could still slow growth more CONFIDENTIAL AND PROPRIETARY. 11. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. World Growth Remains Strong (Real GDP, % change) 10 8 6 4 2 0 United States Western Europe 2006 Japan 2007 Eastern Other Latin Mid East SubEurope Asia-Pac America &N Saharan Africa Africa 2008 2009 Source: Global Insight and S&P CONFIDENTIAL AND PROPRIETARY. 12. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2010 And Comes Mostly From Asia (IMF purchasing power weights, 2006) Other 20% US 20% Other 17% US 12% Eurozone 9% East Eur 7% Japan 3% East Eur 11% Eurozone 15% India 6% Japan 6% China 15% Other Adv 7% India 11% Other Adv 11% Percent of World GDP China 30% Percent of World Growth Source: IMF CONFIDENTIAL AND PROPRIETARY. 13. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 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. 14. 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. 15. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2020 Can the Consumer Keep Spending? • Consumer spending has led the expansion • But wealth is down because home prices declined and • Stocks are weak • Borrowing is more difficult, and home equity loans much less available • Confidence has dropped • Consumers are likely to save more • But rebates will provide some quick cash • Most of which will be spent CONFIDENTIAL AND PROPRIETARY. 16. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Oil Prices Hit New Records ($/barrel, WTI and deflated by CPI; household energy purchases as percent of disposable income) 160 140 120 100 80 60 40 20 0 1980 10% 9% 8% 7% 6% 5% 4% 3% 1985 1990 Oil price (WTI) 1995 2005 dollars 2000 2005 % of disp. income (right) Source: BEA CONFIDENTIAL AND PROPRIETARY. 17. 2010 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. 18. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. India World 2004 No Savings, But Lots of Debt (Percent of after-tax income) 10 140% 8 130% 6 120% 4 110% 2 100% 0 90% -2 80% 1990 1993 1996 1999 2002 2005 2008 2011 Saving rate Debt/income (right) Source: BEA and Federal Reserve CONFIDENTIAL AND PROPRIETARY. 19. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Borrowing Against Your Home $700.00 $600.00 $500.00 $400.00 $300.00 $200.00 $100.00 $0.00 1994 1996 1998 2000 Home equity cashed out 2002 2004 Home equity loans Source: Freddie Mac CONFIDENTIAL AND PROPRIETARY. 20. 2006 Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2008 Stock Market Looks Low Relative To Bonds (Earnings yield on stocks vs 10-year Treasury) 10 8 6 4 2 0 1990 1993 1996 Earnings/price 1999 2002 2005 Bond yield Source: S&P and Census Bureau CONFIDENTIAL AND PROPRIETARY. 21. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2008 2011 Sluggish Ad Revenue (Annual percent change) 8 6 4 2 0 -2 -4 -6 -8 -10 2005 2006 Total 2007 2008 TV Source: McCann Universal, S&P projections CONFIDENTIAL AND PROPRIETARY. 22. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 2009 Radio Bottom Line: The Economy Will Recover Slowly • The recession is expected to be mild but long • But fiscal policy stimulus will end, keeping the recovery slow • If financial markets remain locked up • Home prices continue to fall • And oil prices continue to rise • This could turn into a deeper recession • But we could still avoid recession if • Financial markets regain confidence • And oil prices fall CONFIDENTIAL AND PROPRIETARY. 23. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Risks to the Economy (Real GDP, percent change year ago) 6% 4% 2% 0% -2% -4% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Baseline Pessim Source: BEA, S&P projections CONFIDENTIAL AND PROPRIETARY. 24. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Optim • For subscription information or to inquire about a trial, contact [email protected]. • To help evaluate your strategic portfolio positioning, develop your investment ideas and identify potential gaps and opportunities, Standard and Poor's Global Fixed Income Research provides top down information on: – Global credit trends – Macroeconomic conditions – Sector-specific developments that impact the global capital markets including ratings transitions and anomalies – Distressed, default and recovery research • Global Fixed Income Research will be available through RatingsDirect, the online source for Standard and Poor's Credit Ratings and Research. CONFIDENTIAL AND PROPRIETARY. 25. 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. 26. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s.