OUTLOOK FOR THE U.S. ECONOMY AND FINANCIAL MARKETS GIC/PCBE Luncheon Philadelphia February 1, 2006
A Presentation by:
Martin H. Barnes Managing Editor The Bank Credit Analyst mbarnes@BCAresearch.com
1002 Sherbrooke St. W. Suite 1600, Montreal, Quebec, H3A 3L6 TEL 514.499.9550 FAX 514.843.1763 www.BCAresearch.com
Unusual Times Ann% Chg
Ann% Chg
REAL HOUSE PRICES*
8
8
4
4
0
0
-4
-4
% 9
AFTER-TAX CORPORATE PROFITS AS A % OF NATIONAL INCOME
% 9
8
8
7
7
6
6
5
5
$/Bbl
$/Bbl
MEAN (1955 - 2005) 2 STANDARD DEVIATIONS
REAL** WTI CRUDE OIL PRICE 80
80
60
60
40
40
20
20
%
%
PERSONAL SAVING RATE
10
10
6
6
2
2
TRADE DEFICIT ON GOODS AND SERVICES AS A % OF GDP
%
%
0
0
-2
-2
-4
-4 © BCA Research 2006
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
*SOURCE: NATIONAL ASSOCIATION OF REALTORS; SMOOTHED AND DEFLATED BY THE CONSUMER PRICE INDEX **DEFLATED BY THE CONSUMER PRICE INDEX
2 2 editors@BCAresearch.com February 2006
BCA RESEARCH
Inflation Pressures Have Peaked Ann% Chg
Ann% Chg
CORE* PPI CRUDE GOODS
20
20
10
10
0
0
-10
-10
Ann% Chg
Ann% Chg
CORE* PPI INTERMEDIATE GOODS
6
6
4
4
2
2
0
0
-2
-2 BCA PIPELINE INFLATION PRESSURE INDEX
110
110
100
Ann% Chg
CORE* PCE INFLATION
Ann% Chg
2.0
2.0
1.6
1.6
1.2
1.2
Ann% Chg 1
CORE* CPI GOODS
Ann% Chg 1
0
0
-1
-1
-2
-2
100 Ann% Chg
90
CORE* CPI SERVICES
Ann% Chg
90
%
% NFIB PLANNED PRICE HIKES**
30
3.8
3.8
3.4
3.4
3.0
3.0
2.6
30
25
25
20
20
2.6
15
15
Ann% Chg 0
Ann% Chg 4.0
EMPLOYMENT COST INDEX: WAGES & SALARIES
Ann% Chg 0
Ann% Chg 4.0
3.5
3.5
3.0
3.0
2.5
IMPORT PRICE INFLATION FROM ASIA**
-2
-2
-4
-4
2.5 © BCA Research 2006
2000
© BCA Research 2006
2002
2004
*CORE EXCLUDES FOOD AND ENERGY **SOURCE: NATIONAL FEDERATION OF INDEPENDENT BUSINESS
2000
2002
2004
*CORE EXCLUDES FOOD AND ENERGY **INCLUDES HONG KONG, SINGAPORE, SOUTH KOREA AND TAIWAN
3 BCA RESEARCH
editors@BCAresearch.com February 2006 3
Global Inflation Is Low % 2.5
% CORE* CPI
Ann% Chg
2.5
Ann% Chg
CHINA**
2
2
1
1
0
0
-1
-1
EMU 2.0
2.0
1.5
1.5
Ann% Chg
1.0
1.0 %
Ann% Chg
ASIA EX. CHINA*** CORE* CPI
4
4
% U.K.
2
1.5
2
1.5
Ann% Chg 1.0
JAPAN
Ann% Chg
1.0
.5
.5
1
1
0
0
-1 0 1998
2000
2002
-1
0
© BCA Research 2006
© BCA Research 2006
1998
2004
2000
2002
2004
*EXCLUDES FOOD AND ENERGY **NON-FOOD CPI ***KOREA, TAIWAN AND THAILAND
*EXCLUDES FOOD AND ENERGY
Inflation Rates For Selected High-Frequency Spending Items % Change in consumer prices: December 2004 to December 2005 Gas and electricity Gasoline
17.6 16.1
Tax and accounting services Vehicle repair
4.4 3.6
Delivery services Repair of household items College tuition
9.9 6.8 6.6
Movies and theatre tickets Legal services Cable and satellite
3.5 3.4 3.3
Sporting tickets
6.4
Hotels
3.3
Cigarettes Dental services Child care and nursery Intracity transport
5.9 5.7 5.5 5.4
Physician services Personal Care Services Food Laundry services
3.1 2.7 2.3 1.8
Parking Veterinary services Prescription Drugs
4.9 4.9 4.4
Newspapers and magazines Alcohol Telephone services
1.7 1.3 0.4
4 4 editors@BCAresearch.com February 2006
BCA RESEARCH
Corporate Profitability Is Excellent %
% TOTAL ADJUSTED* AFTER-TAX PROFITS AS A % OF NATIONAL INCOME
9
9
8
8
7
7
6
6
5
5
%
NON-FINANCIAL CORPORATE SECTOR PROFITS BEFORE INTEREST AND TAXES AS A % OF GDP
%
20
20
15
15
© BCA Research 2006
10
10
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
*ADJUSTMENTS INCLUDE INVENTORY VALUATION AND DEPRECIATION
A Different Kind Of Cycle 180
REAL* EBIT
180
130
130
NON-FINANCIAL CORPORATE SECTOR PRICE INDEX
120
120
110
110
100
100
160
160
140
140
120
120
CURRENT CYCLE AVERAGE OF PAST 4 CYCLES*
90 100
100 CURRENT CYCLE AVERAGE OF PAST 4 CYCLES**
REAL GDP
115
120
90
NON-FINANCIAL CORPORATE SECTOR PRODUCTIVITY
115
120
110
110
100
110
110
105
105
100
100
100 95
95
© BCA Research 2006
2000
2002
2004
2006
*ADJUSTED BY THE NON-FINANCIAL CORPORATE SECTOR DEFLATOR **SERIES ARE ALIGNED AT THE START OF EXPANSION REPRESENTED BY 5 THE VERTICAL LINE
BCA RESEARCH
© BCA Research 2006
2000
2002
2004
2006
*SERIES ARE ALIGNED AT THE START OF EXPANSION REPRESENTED BY THE VERTICAL LINE
editors@BCAresearch.com February 2006 5
Balance Sheets Are Strong % 220
% 220
NON-FINANCIAL CORPORATE SECTOR: NET WORTH AS A % OF GDP
200
200
180
180
160
160
140
140
AS A % OF GDP: DEBT (LS) ASSETS (RS)
% 90
% 360
80 320 70 280
60 50
240
%
SHORT-TERM ASSETS AS A % OF LIABILITIES
%
60
60
40
40
20
20
%
DEBT AS A % OF EQUITY
%
100
100
80
80
60
60
40
40
%
INTEREST COSTS AS A % OF EBIT*
%
30
30
20
20
10
10 © BCA Research 2006
55
60
65
70
75
80
85
90
95
2000
05
*EARNINGS BEFORE INTEREST AND TAXES
6 6 editors@BCAresearch.com February 2006
BCA RESEARCH
Good Support For Corporate Spending %
% NON-FINANCIAL CORPORATE SECTOR: WEIGHTED AVERAGE REAL COST OF CAPITAL AVERAGE RETURN ON CAPITAL
8
8
6
6
4
4
NON-FINANCIAL CORPORATE SECTOR GAP BETWEEN RETURN AND COST OF CAPITAL* (LS) NON-RESIDENTIAL FIXED INVESTMENT* (RS)
%
Ann% Chg 20
4
10 2
0 0 -10
RATIO OF NON-RESIDENTIAL FIXED INVESTMENT TO NON-FINANCIAL CORPORATE SECTOR CASH FLOW
1.4
1.4
1.2
1.2
1.0
1.0 © BCA Research 2006
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
*SERIES ARE SHOWN AS 4-QUARTER MOVING AVERAGES
7 BCA RESEARCH
editors@BCAresearch.com February 2006 7
Consumers Set To Retrench
The Impact Of Housing And Oil Ann% % of Disp. Income Chg 8 1.5
CONSUMER CONFIDENCE* (LS) REAL WAGES AND SALARIES** (RS) 140
6 120 4 100
% of Disp. Income
HOME EQUITY EXTRACTION: TOTAL CASH RAISED (ANNUAL CHANGE)
1.5
1.0
1.0
.5
.5
0
0
-.5
-.5
-1.0
-1.0
2 80 0 60 CONSUMER CONFIDENCE* (LS) HOUSE PRICES*** (RS)
Ann% % of Disp. Income Chg
140
12
120
% of Disp. Income
CONSUMER SPENDING ON ENERGY* (ANNUAL CHANGE)
.5
.5
0
0
-.5
-.5
-1.0
-1.0
100 8 80 4
60 PAYROLL GROWTH BCA PAYROLL EMPLOYMENT MODEL****
Ann% Chg
Ann% % of Disp. Income Chg
2
2
0
0
-2
-2
%
PERSONAL SAVING RATE (3-MONTH M.A.)
%
NET STIMULUS/DRAG: HOUSING MINUS ENERGY
% of Disp. Income
1
1
0
0
-1
-1
%
CONSUMER SPENDING ON ENERGY* AS A % OF PERSONAL DISPOSABLE INCOME
%
4
4
6
6
5
5
2
2
0
0
4
© BCA Research 2006
1996
1998
2000
2002
2004
2006
*SOURCE: THE CONFERENCE BOARD **ADJUSTED BY THE PCE DEFLATOR ***SOURCE: NATIONAL ASSOCIATION OF REALTORS; SMOOTHED ****BASED ON HELP-WANTED ADS, NFIB HIRING PLANS AND TEMPORARY EMPLOYMENT
© BCA Research 2006
1994
1996
1998
2000
2002
2004
4
2006
*INCLUDES GASOLINE, FUEL OIL, NATURAL GAS, AND ELECTRICITY NOTE: 2005 IS BCA ESTIMATE FOR ALL SERIES
8 8 editors@BCAresearch.com February 2006
BCA RESEARCH
Consumer Finances Are O.K.
No Sign Of Debt Stress
%
% HOUSEHOLD DEBT AS A % OF PERSONAL DISPOSABLE INCOME
120
120
%
% BANK LOAN DELINQUENCY RATES:
3.2
RESIDENTIAL REAL ESTATE LOANS
2.8
100
3.2 2.8
100
80
80
60
60
2.4
2.4
2.0
2.0
1.6
1.6
%
%
% HOME MORTGAGES AS A % OF CREDIT MARKET DEBT
72
%
OTHER CONSUMER LOANS
3.2
3.2
2.8
2.8
2.4
2.4
72
68
68
© BCA Research 2006
64
64
%
%
1992
HOUSEHOLD NET WORTH AS A % OF PERSONAL DISPOSABLE INCOME
600
600
550
550
500
500
450
450
%
%
EFFECTIVE CONSUMER BORROWING RATES: HOMEOWNER RENTER COMPOSITE*
18
18
14
1994
1996
1998
2000
2002
2004
2006
“Consumer short term debt… is approaching a historical turning point. Having risen at an abnormally fast rate for ten years, it must soon adjust itself to the nation’s capacity for going into hock… which is not limitless. Whether the rate of growth in consumer debt will slow down is no longer the question…it must slow down.” Fortune Magazine March 1956
14
10
10
6
6
© BCA Research 2006
80
82
84
86
88
90
92
94
96
98 2000 02
04
06
*A COMPOSITE OF MORTGAGE, CREDIT CARD, AUTO, AND OTHER DEBT, WEIGHTED BY THE AMOUNTS OUTSTANDING
“Federal Reserve Chairman G. William Miller said the average American buyer is getting dangerously deep in debt, and warned that the trend could have serious consequences… Several of the nation’s business leaders said they share Miller’s alarm over the level to which consumer debts have climbed.” Washington Post October 1978
9 BCA RESEARCH
editors@BCAresearch.com February 2006 9
A Different Kind Of A Flat Yield Curve %
% 10-YEAR TREASURY YIELD MINUS 3-MONTH TREASURY BILL RATE
4
4
3
3
2
2
1
1
0
0
%
REAL* 3-MONTH TREASURY BILL RATE
%
6
High real rates
4
6
High real rates
4
Low real rates
2
2
0
-2
0
© BCA Research 2006
1984
1986
-2 1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
*ADJUSTED BY THE CONSUMER PRICE INDEX
Still A Large Monetary Overhang %
%
MZM AS A % OF GDP 55
55
Monetary overhang
50
50
45
45
40
40
© BCA Research 2006
35 1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
35
2006
10 10 editors@BCAresearch.com February 2006
BCA RESEARCH
U.S. Treasurys: A Return To Stability %
% 10-YEAR TREASURY YIELD
12
12
10
10
8
8
6
6
4
4 © BCA Research 2006
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Real Yields: It Is Different This Time %
% REAL U.S. 10-YEAR TREASURY YIELD* AVERAGE OF PAST 5 CYCLES (LS) CURRENT CYCLE (RS)
7
7
6
6
5
5
4
4
3
3
2
2 © BCA Research 2006
2004
2005
NOTE: PREVIOUS CYCLES ALIGNED TO FIRST RATE HIKE OF TIGHTENING CYCLE, DENOTED BY VERTICAL LINE *SHADING DENOTES RANGE OF REAL 10-YEAR YIELD DURING PREVIOUS TIGHTENING CYCLES
11 BCA RESEARCH
editors@BCAresearch.com February 2006 11
Global Real Yields: Converging At A Low Level
Excess Global Savings
%
% REAL* 10-YEAR BOND YIELDS:
4
4
EMU
3
200
200
150
150
100
100
50
50
2
U.K.
%
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
%
Bn US$
ASIAN* TRADE BALANCE
3
2
%
Bn US$
JAPAN
Bn US$
Bn US$
TRADE BALANCE: LATAM** PLUS EURO AREA
120
120
80
80
40
40
%
2.0
2.0
1.5
1.5
1.0
1.0
Bn US$
.5
.5
100
100
80
80
60
60
40
40
20
20
Bn US$ RUSSIAN TRADE BALANCE
%
CANADA
%
4
4
3
3
2
2
%
Bn US$
OPEC TRADE BALANCE
%
G-7 ex. U.S. U.S.
4
Bn US$
4
3
3
2
2
180
180
140
140
100
100
60
1 1998
2000
60 © BCA Research 2006
1
© BCA Research 2006
2002
2004
*ADJUSTED BY THE BCA ESTIMATE OF LONG-TERM INFLATION EXPECTATIONS
2006
1994
1996
1998
2000
2002
2004
*INCLUDES JAPAN **INCLUDES MEXICO, BRAZIL, CHILE, ARGENTINA, VENEZUELA AND COLOMBIA
12 12 editors@BCAresearch.com February 2006
BCA RESEARCH
The Bull Market In Perspective S&P 500 INDEX CURRENT CYCLE AVERAGE OF PAST 8 POST-BEAR MARKET RALLIES
180
180
4th year 3rd year 2nd year 1st year
160
160
140
140
120
120
100
100 © BCA Research 2006
2001
2002
2003
2004
2005
2006
NOTE: INDEXED TO 100 AT THE STOCK MARKET TROUGH
Tighter Money Leads To Lower Equity Multiples S&P 500 P/E RATIO BASED ON OPERATING EARNINGS
30
30
20
20
10
10
%
%
FED FUNDS RATE
18
18
14
14
10
10
6
6
2
2
© BCA Research 2006
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
NOTE: SHADING DENOTES PERIODS OF RISING FED FUNDS RATE
13 BCA RESEARCH
editors@BCAresearch.com February 2006 13
Measures Of Equity Valuation 30
30
S&P 500 P/E BASED ON OPERATING EARNINGS
25
25
20
20
15
15
10
10
S&P 500 P/E BASED ON OPERATING EARNINGS PLUS LONG-TERM GOVERNMENT BOND YIELD
36
36
32
32
28
28 MEAN 1982-1997
24
24
20
20
16
16
NON-FINANCIAL CORPORATE SECTOR EQUITIES TO REPLACEMENT COST BOOK VALUE 1.6
1.6
1.2
1.2
.8
.8
.4
.4
%
REAL* 10-YEAR TREASURY MINUS S&P 500 EARNINGS YIELD
%
0
0
-5
-5
-10
-10 © BCA Research 2006
1970
1975
1980
1985
1990
1995
2000
2005
*ADJUSTED BY THE BCA ESTIMATE OF LONG-TERM INFLATION EXPECTATIONS
14 14 editors@BCAresearch.com February 2006
BCA RESEARCH
S&P 500 Earnings Growth Set To Slow Ann% Chg
Ann% Chg S&P 500 PROFIT GROWTH BCA EARNINGS MODEL*
20
20
0
0
-20
-20
Š BCA Research 2006
1998
2000
2002
2004
2006
*BASED ON THE YIELD CURVE, DOLLAR, OIL PRICES, REAL CORPORATE BOND YIELDS AND A CORPORATE PROFIT MARGIN PROXY
Decomposing Equity Market Returns Average Annual % Change Historical Average 1950-95
Bubble Years 1996-2000
Bear Market 2000-02
Optimistic Scenario* 2005-15
MeanReversion Scenario** 2005-15
Bear Scenario*** 2005-15
Nominal GDP
7.6
5.9
3.5
5.0
5.0
5.0
Earnings
6.7
9.5
-9.0
5.0
4.5
4.0
2.3
13.3
-8.2
1.5
0.0
-2.5
9.0
22.8
-17.2
6.5
4.5
1.5
4.2
2.0
1.2
1.8
1.8
1.8
13.2
24.8
-16.0
8.3
6.3
3.3
Inflation (CPI)
4.2
2.4
2.3
2.0
2.0
2.0
Real returns
8.6
21.9
-17.9
6.2
4.2
1.3
+ Valuation change +Growth in S&P 500 + Reinvested dividends = Total equity returns
* Assumes that the forward price-earnings ratio to 18 over the period. ** Assumes that the price-earnings ratio remains at its current level near 15. *** Assumes that the price-earnings ratio falls to 12 over the period.
15 BCA RESEARCH
editors@BCAresearch.com February 2006 15
Dollar Bear Market In Perspective
Dollar Versus Regional Trade Imbalances %
100
REAL TRADE-WEIGHTED DOLLAR*
REAL TRADE-WEIGHTED DOLLAR (LS) TRADE DEFICIT/GDP (RS)
100 130
TOTAL 90
90
80
80
4
120
110 2 100 70
70 90
REAL TRADE-WEIGHTED DOLLAR: MAJOR CURRENCIES* 100
0
MAJOR TRADING PARTNERS
%
100 130 CURRENT CYCLE (LS) 1985 CYCLE (RS)
90
90
2
120 110
80
1
80 100
70
70
60
60
90 0
80
REAL TRADE-WEIGHTED DOLLAR: OTHER IMPORTANT TRADING PARTNERS*
OTHER IMPORTANT TRADING PARTNERS
%
130 105
105
100
100
95
95
90
90
85
85
80
80
120
2
110
100
1
90 © BCA Research 2006
© BCA Research 2006
YEARS FROM THE PEAK *SOURCE: THE FEDERAL RESERVE NOTE: ALL SERIES ARE REBASED TO 100 AT THE PEAK IN THE REAL TRADE-WEIGHTED DOLLAR REPRESENTED BY THE VERTICAL LINE
1975
1980
1985
1990
1995
2000
0
2005
16 16 editors@BCAresearch.com February 2006
BCA RESEARCH