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 Economic Outlook: How Hard A Landing? David Wyss Chief Economist Standard & Poor’s NAHB Outlook Conference Washington October 18, 2006

2. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. The 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.

3. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Another Soft Landing

4. CONFIDENTIAL AND PROPRIETARY. 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) Source: BEA

5. CONFIDENTIAL AND PROPRIETARY. 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) Source: OECD

6. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. (Percent) The Fed Is Moving Toward Neutral Source: Federal Reserve

7. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Interest Rates Had Converged (Long-term government bonds) Source: Bloomberg

8. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Quality Spreads Grind Tighter (Spread over Treasury yields, basis points) Source: S&P

9. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Financial Risk Is Greater Source: S&P

10. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. But Corporate Debt Has Dropped Source: Federal Reserve Flow of Funds

11. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. World Growth Is Steady (Real GDP, % change) Source: Global Insight and S&P

12. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. And Comes Mostly From Asia (IMF purchasing power weights, 2005) Percent of World GDP Percent of World Growth Source: IMF

13. CONFIDENTIAL AND PROPRIETARY. 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) Source: IMF

14. CONFIDENTIAL AND PROPRIETARY. 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) Source: S&P

15. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Aging Populations Will Boost Government Spending (Ratio of over 65 population to labor force) Source: OECD

16. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. US Trade Deficit Balances Surpluses Overseas (Trade balance as percent of GDP, 2005) Source: Global Insight

17. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. (Percent of GDP) US Borrows From Abroad to Offset Weak Savings Source: BEA

18. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 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

19. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Household Debt Hits Record As Saving Goes Negative (Percent of after-tax income) Source: BEA and Federal Reserve

20. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. More Mortgages, Fewer Credit Cards And Other Loans (Percent of household debt, 2004) Source: Federal Reserve SCF

21. CONFIDENTIAL AND PROPRIETARY. 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) Source; Federal Reserve

22. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. (Millions of units) Source: Census Higher Interest Rates Slow Car Sales And Housing Starts

23. CONFIDENTIAL AND PROPRIETARY. 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) Source: Federal Reserve

24. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Debt Repayments Are Evenly Distributed (Average debt repayment as percent of income by income percentile) Source: SCF

25. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. The Rich Have Mortgages, The Poor Have Credit Cards (Percentage of households with debt owed) Source: SCF

26. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. 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

27. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. More Affordable Housing Allows Households To Own Homes Source: Census Bureau

28. CONFIDENTIAL AND PROPRIETARY. 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) Source: BEA

29. CONFIDENTIAL AND PROPRIETARY. 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, ) (* Based on 2 years’ of data) Source: The Economist

30. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. The Most Expensive Cities Source: Census; 2005 data

31. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. The Stock Market Will Recover, But Slowly Market rose over 20%/year from But dropped from March 2000 through June 2003 Biggest drop since 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

32. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Most US Sectors Have Recovered From The Bear Market (Change in S&P 500 sectors since March 24, 2000 peak) Source: S&P

33. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s. Bottom Line: The Economy Recovers, But Slowly Consumers are spending their max Businesses are taking over the lead But fiscal policy stimulus is over Interest rates are up Weak recovery for stock market Risk of recession remains if: – Further terror attacks damage confidence, while oil prices soar – Problems in financing deficits push investment down and savings up But could be better if productivity stays stronger

34. CONFIDENTIAL AND PROPRIETARY. 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) Source: BEA, S&P projections

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