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Martin Barnes Managing Editor The Bank Credit Analyst Peering Through the Mist Strategic Investor Conference - La Jolla April 22-24, 2004.

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Presentation on theme: "Martin Barnes Managing Editor The Bank Credit Analyst Peering Through the Mist Strategic Investor Conference - La Jolla April 22-24, 2004."— Presentation transcript:

1 Martin Barnes Managing Editor The Bank Credit Analyst Peering Through the Mist Strategic Investor Conference - La Jolla April 22-24, 2004

2 KEY MESSAGES 1.The U.S. economic expansion is sustainable. 2.The Fed is falling behind the curve: inflation will pick up in the coming year. 3.The trends in domestic debt are unsustainable, but do not pose any immediate threat to the economic and financial outlook. 4.No major asset class offers compelling value right now. However, stocks should outperform both bonds and cash this year and next.

3 REFLATION TRADES (Part I) 240 200 160 120 200120022003 240 200 160 120 1.0.9.8.7.6 1.0.9.8.7.6 CORPORATES MINUS TREASURYS (OAS)** BPs STOCK-TO-BOND TOTAL RETURN RATIO* *INDEXED TO JANUARY 2001 = 1 **SOURCE: MERRILL LYNCH; OPTION-ADJUSTED SPREAD © BCA Research 2004

4 REFLATION TRADES (Part II) © BCA Research 2004 320 300 280 260 240 220 200120022003 320 300 280 260 240 220 1.0.9.8.7.6 1.0.9.8.7.6 CRB* RAW INDUSTRIALS INDEX 40-WEEK MOVING AVERAGE S&P CYCLICAL STOCKS/NON-CYCLICAL STOCKS *CRB = COMMODITY RESEARCH BUREAU

5 MASSIVE MONETARY STIMULUS © BCA Research 2004 10 8 6 4 2 1986198819901992199419961998200020022004 10 8 6 4 2 FED FUNDS TARGET RATE GDP GROWTH % %

6 STRONG REVIVAL IN BUSINESS CONFIDENCE © BCA Research 2004 70 60 50 40 30 1998199920002001200220032004 70 60 50 40 30 60 55 50 45 40 60 55 50 45 40 CONFERENCE BOARD BUSINESS CONFIDENCE INDEX AVERAGE OF ISM MANUFACTURING AND NON-MANUFACTURING INDEXES* % % *SOURCE: INSTITUTE FOR SUPPLY MANAGEMENT

7 CONSUMER SPENDING SUPPORTED BY INCOMES © BCA Research 2004 4 3 2 1 19961998200020022004 4 3 2 1 6 4 2 6 4 2 PERSONAL SAVING RATE* % % REAL CONSUMER SPENDING* REAL PERSONAL DISPOSABLE INCOME* Ann% Chg *SHOWN AS A 3-MONTH MOVING AVERAGE Ann% Chg

8 HEALTHY TREND IN CONSUMER INCOMES © BCA Research 2004 14 12 10 1998200020022004 14 12 10 8 6 4 2 8 6 4 2 AVERAGE EFFECTIVE TAX RATE % PERSONAL INCOME DISPOSABLE INCOME NOTE: ALL SERIES ARE SHOWN AS A 3-MONTH MOVING AVERAGE Ann% Chg %

9 A GLOBAL RECOVERY © BCA Research 2004.4 0 -.4 -.8 199419961998200020022004 8 4 0 -4 102 101 100 99 4 0 -4 BCA GLOBAL LEADING ECONOMIC INDICATOR EX. U.S. (LS) GLOBAL INDUSTRIAL PRODUCTION EX. U.S. (RS) U.S.: LEADING ECONOMIC INDICATOR (LS) INDUSTRIAL PRODUCTION (RS) Ann% Chg

10 RECESSIONS USUALLY TRIGGERED BY TIGHT MONEY © BCA Research 2004 4 2 0 -2 196019651970197519801985199019952000 4 2 0 -2 6 4 2 0 6 4 2 0 10-YEAR MINUS 3-MONTH TREASURY YIELD % % REAL GDP NOTE: SHADED AREAS CORRESPOND TO NBER-DESIGNATED PERIODS OF RECESSION Ann% Chg

11 A STUNNING REBOUND IN PROFITS © BCA Research 2004 9 8 7 6 5 4 3 196019651970197519801985199019952000 9 8 7 6 5 4 3 8 7 6 5 4 8 7 6 5 4 NON-FINANCIAL CORPORATE SECTOR: WEIGHTED AVERAGE REAL COST OF CAPITAL AVERAGE RETURN ON CAPITAL % % TOTAL CORPORATE AFTER-TAX PROFITS AS A % OF GDP % %

12 INFLATION TURNS THE CORNER © BCA Research 2004 2 1 0 199419961998200020022004 2 1 0 2 1 0 2 1 0 2.5 2.0 1.5 2.5 2.0 1.5 IMPORT PRICES FOR CONSUMER GOODS & AUTOS CORE* PPI FINISHED GOODS CORE* CPI *CORE EXCLUDES FOOD AND ENERGY Ann% Chg

13 THE TWO SIDES OF INFLATION © BCA Research 2004 4 3 199419961998200020022004 4 3 0 -2 0 CORE* CPI SERVICES EXCLUDING RENT OF SHELTER CORE* CPI GOODS *CORE EXCLUDES FOOD AND ENERGY Ann% Chg

14 IS HOUSING IN A BUBBLE? © BCA Research 2004 1.3 1.2 1.1 198419881992199620002004 1.3 1.2 1.1 2.0 1.9 1.8 2.0 1.9 1.8 HOUSE PRICES* / CPI RENT OF SHELTER HOUSE PRICES* / EMPLOYEE COMPENSATION RATIO *SOURCE: OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT

15 IS HOUSING IN A BUBBLE? © BCA Research 2004 140 120 100 80 198219861990199419982002 140 120 100 80 8 6 4 2 8 6 4 2 HOUSING AFFORDABILITY INDEX** HOUSE PRICES* *SOURCE: OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT **SOURCE: NATIONAL ASSOCIATION OF REALTORS Ann% Chg

16 IS CONSUMER DEBT A PROBLEM? 100 90 80 70 60 50 19601970198019902000 100 90 80 70 60 50 HOUSEHOLD DEBT AS A % OF PERSONAL DISPOSABLE INCOME % © BCA Research 2004

17 “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 “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

18 CONSUMERS NOT IN FINANCIAL STRESS © BCA Research 2004 4.2 3.8 3.4 3.0 2.6 19901992199419961998200020022004 4.2 3.8 3.4 3.0 2.6 3.2 2.8 2.4 2.0 3.2 2.8 2.4 2.0 ALL CONSUMER LOANS % % RESIDENTIAL REAL ESTATE LOANS BANK LOAN DELINQUENCY RATES: % %

19 TREASURYS ARE OVERVALUED © BCA Research 2004 1 0 -2 19901992199419961998200020022004 1 0 -2 9 8 7 6 5 4 9 8 7 6 5 4 BCA 10-YEAR TREASURY VALUATION INDEX Bonds Extremely Undervalued 10-YEAR TREASURY YIELD FAIR VALUE PROJECTED BY BCA BOND MODEL % % Bonds Extremely Overvalued

20 STOCKS ARE NOT CHEAP © BCA Research 2004 0 -4 -8 -12 1980198419881992199620002004 0 -4 -8 -12 1.6 1.2.8 1.6 1.2.8 25 20 15 10 5 25 20 15 10 5 S&P 500 DIVIDEND YIELD MINUS 3-MONTH TREASURY BILL YIELD % % NONFINANCIAL CORPORATE SECTOR EQUITIES TO REPLACEMENT COST BOOK VALUE S&P 500 FORWARD P/E RATIO* *BASED ON 12-MONTH FORWARD EARNINGS

21 STILL LOTS OF CASH ON THE SIDELINES © BCA Research 2004 220 180 140 100 60 198219861990199419982002 220 180 140 100 60 50 40 30 60 50 40 30 INTEREST INCOME FROM CASH MOUNTAIN* (IN 2003 PRICES) Bn$ CASH MOUNTAIN* AS A % OF PERSONAL DISPOSABLE INCOME % % *INCLUDES MONEY MARKET FUNDS AND SAVINGS DEPOSITS

22 DECOMPOSING EQUITY MARKET RETURNS © BCA Research 2004 Historical Average 1950-95 Bubble Years Bear Market 2000-02 Optimistic Scenario Mean- Reversion Scenario** Bear Scenario*** 2004-14 Nominal GDP Earnings +Valuation change =Growth in S&P 500 +Reinvested dividends =Total equity returns Inflation (CPI) Real returns *Bull market ended in 2000 Q3, based on quarterly data. ** Assumes that the price-earnings ratio falls to 15 over the period. ***Assumes that the price-earnings ratio falls to 12 over the period. 7.6 7.6 1.4 9.0 4.3 13.3 4.2 8.7 5.9 9.3 13.7 23.0 2.0 25.0 2.2 22.3 3.2 -8.7 -5.9 -14.6 1.7 -12.9 2.4 -14.9 5.0 5.0 0.0 5.0 1.7 6.7 2.0 5.7 5.0 5.0 -1.8 3.2 1.7 4.9 2.0 4.1 5.0 5.0 -4.0 1.0 1.7 2.7 2.0 1.8 1996-2000*

23 THE DOLLAR MOVES IN LONG CYCLES © BCA Research 2004 130 120 110 100 90 197519801985199019952000 130 120 110 100 90 REAL TRADE-WEIGHTED DOLLAR SOURCE: THE FEDERAL RESERVE

24 WHY THE DOLLAR HAS FURTHER TO FALL © BCA Research 2004 5 4 3 2 1 0 1980198419881992199620002004 5 4 3 2 1 0 CURRENT ACCOUNT DEFICIT AS A % OF GDP NET LONG-TERM CAPITAL FLOWS AS A % OF GDP (PORTFOLIO PLUS DIRECT INVESTMENT)* % *SHOWN AS A 4-QUARTER MOVING AVERAGE

25 GOLD AS A LONG-TERM INVESTMENT © BCA Research 2004 4000 2000 1000 500 100 10 1880190019201940196019802000 4000 2000 1000 500 100 10 REAL RETURN ON: STOCKS BONDS GOLD

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