THE ECONOMIC & FINANCIAL MARKET
OUTLOOK THROUGH 2005:
What Next For The Post-Election Economy?
A Presentation To The Iowa Chapter Of
Financial Executives International
Des Moines, Iowa
January 20, 2005
THE ECONOMIC-POLICY
DEBATE OF 2005
* Sharpening A Classic Division Between Republicans
And Democrats
--What Kind Of “Ownership Society?”
* Finding A Balance Between Growth & Inequality
Vs. A More Equal, Less Efficient Economy
* Ideology Frames The Policy Issues In 2005
--Social Security Reform
--Permanent Tax Cuts
--Tax Reform
RESPECTABLE, BUT STILL SUB-PAR GROWTH
THROUGH 2005
Year-Ago Percent Change In Real GDP
7%
Avg., Previous 5 Long Cycles*
Avg. Annual % Chg.,
6% 1991-2003=3.4% P.A.
Forecast
Current Cycle
5%
4%
3%
2%
1%
0%
-1%
-2%
-1
1
2
3
4
5
6
7
8
9
10
11
12
13
Quarters Before And After The Start Of A Recovery
* Cycles beginning in 1960, 1969, 1974, 1981, 1990.
Source: U.S. Department Of Commerce
14
15
16
IOWA'S ECONOMIC RECOVERY LAGS THE
NATIONAL AVERAGE
Percent Change, Gross Sate/ Domestic Product
4.5%
Forecast
4.0%
3.5%
3.0%
2.5%
2.0%
Iowa
U.S.
1.5%
1.0%
0.5%
0.0%
-0.5%
-1.0%
19982001
2002
2003
2000
Sources: Economy.com, Blue Chip Economic Forecast
2004
2005
200608
GAUGING "DISINFLATION'S" IMPACT ON CORPORATE
"PRICING POWER," COSTS AND PROFIT
Year -Ago Percent Change; Non-Financial Corporations
5%
4%
Note: Bars Denote
Recession Periods
Margin
Pressure
3%
2%
Selling Prices
'04Q3
1%
0%
-1%
Unit Labor Costs
-2%
Margin
Expansion
-3%
-4%
Mar-89 Mar-91 Mar-93 Mar-95
Source: U.S. Commerce Dep't.
Mar-97
Mar-99
Mar-01
Mar-03
Mar-05
A "YELLOW FLAG" ON INFLATION
Year-Ago Percent Change, Non-Energy CPI Goods Vs. Services
Prices
2.0
4.2
Commodities, Ex. Food &
Energy
(Left Scale)
1.5
3.9
1.0
0.5
3.6
0.0
-0.5
3.3
-1.0
11/04
-1.5
-2.0
3.0
Services, Ex. Energy
(Right Scale)
2.7
-3.0
Jan-1996
Jan-1998
Source: U.S. Dep't Of Labor
2.4
-2.5
Jan-2000
Jan-2002
Jan-2004
INVENTORIES STILL "LEAN" OUTSIDE THE
AUTO INDUSTRY
Ratio Of Inventories To Sales
1.800
1.550
Autos
(Left Scale)
1.500
1.690
1.450
1.400
1.580
11/04
1.470
1.350
1.300
1.250
1.360
Excluding Autos
(Right Scale)
1.250
Jan-92
Jan-94
Jan-96
Jan-98
Source: U.S. Department Of Commerce
1.200
1.150
Jan-00
Jan-02
Jan-04
U.S. EXPORTS RESPOND TO A
WEAKER DOLLAR
64
62
% Rept'g An Increase
Index: 2000=100
Export Orders, Mfd. Goods
(Left Scale)
110
12/04
60
112
108
106
58
104
56
102
100
54
98
52
96
50
94
48
46
92
"Real Trade-Weighted"
$*
(Right Scale)
90
1/14/05
44
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
* Based on the dollar's inflation-adjusted, trade-weighted exchange
rate against 44 other currencies.
Sources: Nat'l Ass'n Of Purchasing Mgrs.; J.P. Morgan & Co.
88
86
Dec-03
Dec-04
RAPID-FIRE RATE HIKES FOLLOW
AGGRESSIVE POLICY STIMULUS
The Federal Funds Rate Less The PCE "Deflator;" Percent
5.0
4.0
3.0
Avg., 1969-2003=2.6%
2.0
Fed "Easing" During The Sluggish
1991-92 Recovery
1.0
12/04
0.0
Note: Bars Denote
Recession Periods
-1.0
-2.0
Jan-90
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Sources: Bloomberg Financial News, Inc., U.S. Commerce Dep't
Jan-02
Jan-04
A REPLAY OF THE 1999-2000
INTEREST-RATE “UP CYCLE?”
The Treasury Yield Curve, Selected Periods; Yields In Percent
7.3
Federal Funds Target Rate,
5/16/00=6.50%
5/18/00
6.3
6/29/99
5.3
Fed Funds Target Rate,
11/17/98=4.75%
11/18/98
4.3
0
5
10
15
20
Years To Maturity
Source: Bloomberg Financial News, Inc.
25
30
35
“RISKS” IN THE OUTLOOK
* “LOW-QUALITY” SECTORS UNDER FIRE
* THE HOUSING “BUBBLE” BURSTS
* A DOLLAR TAILSPIN
*OIL-PRICE VOLATILITY
* A CHINESE GROWTH RECESSION
* TERRORISM & OTHER GEO-POLITICAL STRAINS
* “BUSH II” ECONOMIC POLICIES
FISCAL DEFICITS: IN THE EYE OF THE STORM?
Budget Surpluses & Deficits As A % Of GDP; Fiscal Years
3%
Forecast,
2006-10
2%
1%
0%
No Tax
Chgs.=2.3% Of
GDP
-1%
Avg. 1982-92=4.3%
Of GDP
-2%
-3%
-4%
-5%
Wi. Tax & Soc.
Sec.
Chgs.=3.7% Of
GDP
-6%
-7%
1970
1975
1980
1985
1990
Source: Congressional Budget Office & WCM Estimates
1995
2000
2005
2010
HOPEFUL SIGNS OF AN APPROACHING TURN
IN THE U.S. BALANCE-OF-PAYMENTS DEFICIT
6%
Percent Of GDP*
Index: 2000=100*
115
'04Q3
5%
110
4%
105
3%
2%
100
U.S. Payments Deficit
(Left Scale)
Trade-Wtd. U.S. $
(Right Scale)
1%
95
90
1/14/05=87.9
0%
-1%
Dec-84
Dec-87
Dec-90
Dec-93
Dec-96
Dec-99
Dec-02
* Four-quarter moving averages; trade-wtd. $ adjusted for relative inflation rates.
Source: U.S. Commerce Dep't
85
80
IS FOREIGN CONFIDENCE IN THE U.S. STILL INTACT?
Net Foreign Direct Investment In The U.S. Plus
Foreign Private Portfolio Investment; $ Billions
120
100
Rolling 4-Quarter
Average
'04Q3
80
60
40
Rolling 5-Year Moving
Average
20
0
-20
Mar-85
Mar-88
Mar-91
Mar-94
Source: U.S. Commerce Department
Mar-97
Mar-00
Mar-03
THE OUTLOOK FOR S&P 500 EARNINGS GROWTH STILL
FAIRLY UPBEAT
Yr.-Ago % Change In S&P 500 Operating Profits*
27%
22%
17%
Avg. Annual % Chg.,
1983-2003=7.2%
Forecast*
'04Q3-'05Q4
12%
7%
2%
-3%
-8%
-13%
-18%
-23%
Mar-97
Sep-98
Mar-00
Sep-01
Mar-03
Sep-04
* First Call "bottom-up" consensus estimate, including goodwill adjustments.
Source: First Call, Inc.
Mar-06
S&P 500 PRICE-EARNINGS (P/E) MULTIPLE NOT
UNUSUALLY HIGH...
S&P 500 P/E Multiple, Based On Consensus, "Bottom-Up"
Operating. Earnings Forecasts
27
S&P 500 P/E Multiple
(Left Scale)
23
19
1/14/05
P/E=16.1x
Avg. P/E, 1983-2003=14.9 Times
Forward Operating Earnings
15
11
7
3
Jan-79
Jan-83
Jan-87
Jan-91
Jan-95
Sources: Standard & Poors, Inc., IBES, Federal Reserve Board
Jan-99
Jan-03
…AND STILL "CHEAP" AGAINST BONDS, AT CURRENT
INTEREST RATES
Ratio, 10-Yr. Treasury Yield Vs. Earnings-Price Yield (E/P) On S&P 500
Stocks
1.8
1.6
1.4
Avg., 1983-2003=1.016
1.2
1.0
1/14/05
0.8
0.6
0.4
Jan-79
Jan-83
Jan-87
Jan-91
Jan-95
Sources: Standard & Poors, Inc., IBES, Federal Reserve Board
Jan-99
Jan-03
BOND MANAGERS POSITIONED FOR HIGHER
INTEREST RATES RATES
Portfolio "Duration" Vs. Target, In Percent; 4-Wk. Moving
Avgs.
104
103
102
101
100
99
98
"Neutral" (100% Of
Benchmark Duration)
12/14/04
Week
97
96
95
94
25-Dec-01
25-Jun-02
24-Dec-02
24-Jun-03
Source: Stone McCarthy Research Associates, Inc.
23-Dec-03
22-Jun-04
21-Dec-04
LOW TREASURY YIELDS VS. DURATION INCREASE
THE RISK OF NEGATIVE RETURNS
8
7
Duration (In Years)
Yield (In Percentage Points)
5-Yr. Treasury Yield
6
5
11/04
4
5-Yr. Treasury Duration
3
2
Dec-92
Dec-94
Dec-96
Source: Merrill Lynch, Inc.
Dec-98
Dec-00
Dec-02
Dec-04
COMPETING IN A DYNAMIC
GLOBAL ENVIRONMENT
* GLOBAL COMPETITION’S SILVER LINING
--Ongoing Pressure To Boost Productivity Growth Via Tech
Investment, Management & Other Innovations
* “MUTED” BUSINESS CYCLE
* MORE FAVORABLE DEMOGRAPHICS
* THE BENEFITS OF A MORE “MARKET-ORIENTED” FORM
OF CAPITALISM
--Entrepreneurship & Innovation, More Open, Dynamic Labor &
Financial Markets, More Pro-Active Economic Policies