1. The Timing and Scope of the 2002 Rebound Michael R. Englund Chief Market Economist Standard & Poor’s March of 2002

2. Summary Business investment fell sharply in the 2001 recession: Equipment spending plummeted Inventories collapsed at an unsustainable rate U.S. “exported” factory weakness through trade Household and government spending remained robust: Negative wealth effect never materialized Housing and government sectors grew briskly Conditions are in place for a healthy expansion Inflation is under control, and interest rates are low Yield curve is pricing-in healthy growth

3. Part One: The Factory and Tech-Sector Collapse

4. *Shipments of computers and electronics plummeted after December of 2000 to an extremely weak low, but are now turning higher.

5. *The sharp gyration in the technology sector prompted a similar pattern for total domestic expenditures on capital goods overall.

6. The construction component of business investment tracked the equipment sector downward after peaking in Q1 of 2001, and could remain sluggish.

7. *The result of the drops in the two business fixed investment components was a much larger component contraction than seen in the 90-91 recession.

8. The downturn in business inventory investment was even more severe, with an unprecedented collapse in Q4 following the events of 9-11.

9. The annual inventory figures reveal the unusual size of the cumulative 2001 inventory collapse, versus the prior three downturns.

10. Inventory-to-sales ratios were typical for a recession until September, when the ratios went into a powerful freefall, with sales strength but output weakness.

11. *Gross investment, which combines fixed and inventory investment, as well as corporate profits, are now turning upward after a sharp downturn.

12. *Both exports and imports of goods have fallen sharply from a Q3, 2000 peak.

13. *The export slowdown was concentrated in capital equipment, which is a volatile sector in which the U.S. has a comparative advantage.

14. *The import slowdown was, at first, also concentrated in capital equipment, As the U.S. successfully pushed sector weakness abroad through trade.

15. *A trade price freefall is a big part of the “global” goods sector downturn.

16. *The trade price freefall also reflects a reversal in oil prices, which is a reason why it may come to an abrupt end if there is turmoil in the Gulf.

17. *But falling trade prices also reflect a soaring U.S. dollar, and an economic rebound should only exacerbate this upward trend.

18. Part Two: Household and Government Sectors Remain Solid

19. *Hardly any slowdown was seen in U.S. consumption growth, and this component accounts for two-thirds of GDP.

20. *U.S. consumption growth closely tracks disposable income growth, though the relationship was distorted by the Q3/Q4 gyrations in tax rebates.

21. *The mismatch of consumption and income growth is observed in the savings rate. Here, the downtrend has only stalled modestly since 2000, if we ignore the “tax rebate” distortion.

22. *The sharp drop in Asset prices in 2001 exacerbated the presumed “negative wealth” effect, though we now expect a rebound in asset values.

23. *Net worth grew at a 9%-14% rate in each of the five years prior to 2000, before slowing sharply in 2000 to –1% and an estimated -5% in 2001.

24. *The ratio of net worth to nominal GDP soared from 1994 to 1999 because of the huge gains in “real” terms, before plummeting through 2001.

25. Breakdown of U.S. Household Assets, at the End of 2001 Total U.S. Household Assets: $48,396 Bln Real Estate$13,26427% Consumer Durables $2,914 6% Deposits $4,96710% Credit Market Instruments $1,894 4% Corporate Equities $5,83212% Noncorporate businesses $5,10511% Pension Funds $8,72318% Mutual Funds $2,993 6% Other $2,704 6% *Total stock market exposure is roughly 40%.

26. *The housing sector has remained remarkably resilient to events elsewhere, and fiscal and monetary stimulus should boost this sector through 2002.

27. *Construction is heavily skewed toward the southern states, though activity in all four regions remains healthy due to falling interest rates.

28. Stimulative effects of the 2001 tax cuts were already kicking-in when the war on terrorism provided a hefty boost to spending prospects.

29. Accelerating federal government spending will sharply boost total government spending through 2002 and 2003, alongside tax cuts.

30. Part Three: Conditions are in Place For a Healthy Expansion

31. *Inflation rose at the end of the last expansion, but then slowed sharply with with plummeting energy prices and slower economic growth.

32. *Continued firmness in core inflation is troublesome, but this partly reflects the lagged impact of the earlier surge in energy prices, and general lags in the relationship between inflation and the business cycle.

33. *Wage inflation is finally moderating, and the rising unemployment rate should have ongoing beneficial effects on wage price pressure through 2002.

34. *Total employment costs accelerated sharply through 1999 and early-2000, but the run-up paused in 2001, and should moderate somewhat in 2002.

35. *The Fed funds rate revealed an unusually large cyclical drop as the economy slowed, and this provided a big pre-emptive boost to GDP growth in 2002.

36. *On both a nominal and inflation-adjusted basis, the “real” Fed funds rate has been cut sharply over the past year.

37. * Treasury yields at the short end of the curve fell sharply with Fed easing. But yields on longer dated securities fell by less, and yields on corporate bonds and mortgages hardly fell at all.

38. *Yield curve inversions have been a powerful predictor of recessions with a 9-20 month lead, and we had two inversions in 1998 and 2000. Since then, the curve has steepened dramatically as usually occurs in an expansion. “S” = Inversion “Signal” “P” = Cyclical Peak

39. Summary Business investment fell sharply in the 2001 recession: Equipment spending plummeted Inventories collapsed at an unsustainable rate U.S. “exported” factory weakness through trade Household and government spending remained robust: Negative wealth effect never materialized Housing and government sectors grew briskly Conditions are in place for a healthy expansion Inflation is under control, and interest rates are low Yield curve is pricing-in healthy growth