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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.

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THE ECONOMIC & FINANCIAL MARKET OUTLOOK THROUGH 2005: What Next For The Post-Election Economy?

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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 2005Year-Ago Percent Change In Real GDP

7%

Avg., Previous 5 Long Cycles*

Avg. Annual % Chg.,

Forecast

6%

1991-2003=3.4% P.A.

Current Cycle

5%

4%

3%

2%

1%

0%

-1%

-2%

-1

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

Quarters Before And After The Start Of A Recovery

* Cycles beginning in 1960, 1969, 1974, 1981, 1990.

Source: U.S. Department Of Commerce


IOWA'S ECONOMIC RECOVERY LAGS THE NATIONAL AVERAGEPercent Change, Gross Sate/ Domestic Product

4.5%

Forecast

4.0%

3.5%

3.0%

2.5%

Iowa

U.S.

2.0%

1.5%

1.0%

0.5%

0.0%

-0.5%

-1.0%

1998-

2001

2002

2003

2004

2005

2006-

2000

08

Sources: Economy.com, Blue Chip Economic Forecast


GAUGING "DISINFLATION'S" IMPACT ON CORPORATE "PRICING POWER," COSTS AND PROFIT Year -Ago Percent Change; Non-Financial Corporations

5%

Note: Bars Denote

4%

Recession Periods

Margin

Pressure

3%

Selling Prices

'04Q3

2%

1%

0%

-1%

Unit Labor Costs

-2%

Margin

Expansion

-3%

-4%

Mar-89

Mar-91

Mar-93

Mar-95

Mar-97

Mar-99

Mar-01

Mar-03

Mar-05

Source: U.S. Commerce Dep't.


A "YELLOW FLAG" ON INFLATIONYear-Ago Percent Change, Non-Energy CPI Goods Vs. Services Prices

2.0

4.2

Commodities, Ex. Food &

Energy

1.5

(Left Scale)

3.9

1.0

0.5

3.6

0.0

-0.5

3.3

-1.0

11/04

3.0

-1.5

-2.0

Services, Ex. Energy

2.7

(Right Scale)

-2.5

-3.0

2.4

Jan-1996

Jan-1998

Jan-2000

Jan-2002

Jan-2004

Source: U.S. Dep't Of Labor


INVENTORIES STILL "LEAN" OUTSIDE THE AUTO INDUSTRYRatio Of Inventories To Sales

1.800

1.550

Autos

1.500

(Left Scale)

1.690

1.450

1.400

1.580

1.350

11/04

1.470

1.300

1.250

1.360

1.200

Excluding Autos

(Right Scale)

1.250

1.150

Jan-92

Jan-94

Jan-96

Jan-98

Jan-00

Jan-02

Jan-04

Source: U.S. Department Of Commerce


U.S. EXPORTS RESPOND TO A WEAKER DOLLAR

% Rept'g An Increase

Index: 2000=100

64

112

Export Orders, Mfd. Goods

110

(Left Scale)

62

108

12/04

60

106

58

104

102

56

100

54

98

52

96

94

50

92

"Real Trade-Weighted"

48

$*

90

(Right Scale)

46

88

1/14/05

44

86

Dec-98

Dec-99

Dec-00

Dec-01

Dec-02

Dec-03

Dec-04

* 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.


RAPID-FIRE RATE HIKES FOLLOW AGGRESSIVE POLICY STIMULUSThe 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

1.0

1991-92 Recovery

12/04

0.0

Note: Bars Denote

-1.0

Recession Periods

-2.0

Jan-90

Jan-92

Jan-94

Jan-96

Jan-98

Jan-00

Jan-02

Jan-04

Sources: Bloomberg Financial News, Inc., U.S. Commerce Dep't


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,

5/18/00

5/16/00=6.50%

6.3

6/29/99

5.3

Fed Funds Target Rate,

11/18/98

11/17/98=4.75%

4.3

0

5

10

15

20

25

30

35

Years To Maturity

Source: Bloomberg Financial News, Inc.


“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

-1%

GDP

Avg. 1982-92=4.3%

Of GDP

-2%

-3%

-4%

-5%

Wi. Tax & Soc.

Sec.

-6%

Chgs.=3.7% Of

GDP

-7%

1970

1975

1980

1985

1990

1995

2000

2005

2010

Source: Congressional Budget Office & WCM Estimates


HOPEFUL SIGNS OF AN APPROACHING TURN IN THE U.S. BALANCE-OF-PAYMENTS DEFICIT

Percent Of GDP*

Index: 2000=100*

6%

115

'04Q3

5%

110

4%

105

3%

100

U.S. Payments Deficit

(Left Scale)

2%

95

Trade-Wtd. U.S. $

(Right Scale)

1%

90

1/14/05=87.9

0%

85

-1%

80

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


IS FOREIGN CONFIDENCE IN THE U.S. STILL INTACT?Net Foreign Direct Investment In The U.S. Plus Foreign Private Portfolio Investment; $ Billions

120

Rolling 4-Quarter

100

Average

'04Q3

80

60

40

Rolling 5-Year Moving

Average

20

0

-20

Mar-85

Mar-88

Mar-91

Mar-94

Mar-97

Mar-00

Mar-03

Source: U.S. Commerce Department


THE OUTLOOK FOR S&P 500 EARNINGS GROWTH STILL FAIRLY UPBEATYr.-Ago % Change In S&P 500 Operating Profits*

27%

Forecast*

22%

Avg. Annual % Chg.,

'04Q3-'05Q4

1983-2003=7.2%

17%

12%

7%

2%

-3%

-8%

-13%

-18%

-23%

Mar-97

Sep-98

Mar-00

Sep-01

Mar-03

Sep-04

Mar-06

* First Call "bottom-up" consensus estimate, including goodwill adjustments.

Source: First Call, Inc.


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

1/14/05

P/E=16.1x

Avg. P/E, 1983-2003=14.9 Times

19

Forward Operating Earnings

15

11

7

3

Jan-79

Jan-83

Jan-87

Jan-91

Jan-95

Jan-99

Jan-03

Sources: Standard & Poors, Inc., IBES, Federal Reserve Board


…AND STILL "CHEAP" AGAINST BONDS, AT CURRENT INTEREST RATESRatio, 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

Jan-99

Jan-03

Sources: Standard & Poors, Inc., IBES, Federal Reserve Board


BOND MANAGERS POSITIONED FOR HIGHER INTEREST RATES RATES Portfolio "Duration" Vs. Target, In Percent; 4-Wk. Moving Avgs.

104

103

102

101

100

99

"Neutral" (100% Of

12/14/04

Benchmark Duration)

Week

98

97

96

95

94

25-Dec-01

25-Jun-02

24-Dec-02

24-Jun-03

23-Dec-03

22-Jun-04

21-Dec-04

Source: Stone McCarthy Research Associates, Inc.


LOW TREASURY YIELDS VS. DURATION INCREASE THE RISK OF NEGATIVE RETURNS

Duration (In Years)

Yield (In Percentage Points)

8

5-Yr. Treasury Yield

7

6

5

11/04

4

5-Yr. Treasury Duration

3

2

Dec-92

Dec-94

Dec-96

Dec-98

Dec-00

Dec-02

Dec-04

Source: Merrill Lynch, Inc.


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


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