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MPSIF Economic Update. April 5 th , 2004 Stern School of Business New York University. Market Trends: Quarter Recap Big markets flat; Small caps continue to outperform. Dow Jones Industrial Average ↓ 0.91% S&P 500 ↑ 1.29% NASDAQ Composite ↓ 0.84% since Annual Report

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mpsif economic update

MPSIF Economic Update

April 5th, 2004

Stern School of Business

New York University

market trends quarter recap big markets flat small caps continue to outperform
Market Trends: Quarter RecapBig markets flat; Small caps continue to outperform
  • Dow Jones Industrial Average ↓ 0.91%
  • S&P 500 ↑ 1.29%
  • NASDAQ Composite ↓ 0.84% since Annual Report
  • Russell 2000 Index ↑ 6.00%
  • 1Q04 earnings expected to be up 17% yoy (above estimate)
  • March 2004 dividend up 16.5% over March 2003
  • 10-year rates start at 4.15 fall to 3.70 late in March, then return to 4.17 last Friday (rate went up .29% in one day!)
economic fundamentals trends and estimates
Economic Fundamentals – Trends and Estimates
  • Fed Rate:
    • Jobs report increases probability of a Fed increase this summer
    • Futures prices for July and August suggest a 38% and 70% probability of a 25bp increase by those dates, respectively, up from 16% and 32% the day before the jobs report
    • But, these probabilities are down from February, when futures prices were predicting 72% chance of a 25bp increase by July and a 100% chance of a 50bp increase by November
    • Triggers are inflation gap and GDP gap… and election?
  • GDP:
    • 4.1% increase in 4Q03.
    • Analysts continue to expect 4.5% for 2004.
  • Inflation:
    • Reached a 40 year low of 1.1% in November, expected to rise to 2.0% November 2004
    • Import prices have risen 5 consecutive months, but still low.
    • Capacity utilization remains low, but rising.
employment report
Employment Report
  • March Unemployment Rate 5.7%, up from 5.6%
  • Nonfarm payrolls increased 308,000
    • largest gain since April 2000
    • 1st month in 44 mfg jobs did not 
    • 230K of jump from services
  • Signal that more formerly discouraged workers looking for jobs
  • Hourly earnings  measly .1%
    • Annual rate 1.8%
  • Average workweek 33.7 hours, down a bit from 33.8
oil and gas outlook

Crude Oil

Oil and Gas Outlook
  • OPEC cut production quota by 1 mbbl/d in anticipation of seasonal demand reduction
    • Until April 1st, OPEC production at 26 mbbl/day
    • OPEC committed to reduce by 1.5 mbbl/d “cheating” ineffective
    • Decision to cut production contentious within OPEC; Saudis supportive
    • OPEC under pressure from U.S. administration
  • Natural pas prices remain high (supply and demand imbalance)
  • Oil and gas one-month futures prices dropped Friday by 3-4%
    • Caused by strengthened dollar and comments by Kuwaiti and Saudi oil ministers

Conclusion: Oil tough to call; gas prices likely to remain strong

u s currency markets
U.S. Currency Markets
  • Friday’s payroll announcement strengthened dollar relative to euro
    • ECB continues to focus on inflationary pressures, maintaining higher interest rates
  • Dollar has strengthened against the yen in last three weeks
    • Japan had purchased 2/3 (~¥3.5 t) of its 2003 total through March
    • Indications that intervention slowed dramatically in late-March
  • Japanese and Chinese intervention in currency markets has helped finance U.S.’s current account and budget deficits
  • Conclusion: Increasing growth and subsequent increase in interest rates will lesson support for exporters in near-term; influence unlikely to be felt until 2005
fixed income outlook
Fixed Income Outlook
  • Approx. 28% of fund assets are in bond funds
    • Fund charter requires securities to be investment grade
    • ~1/3 each in treasuries, mortgages, and corporate bonds
  • Most spreads over treasuries are below historical level
  • While interest rates stay low, continue receiving coupons
  • However, as rates increase over next year, capital losses likely
  • Recommendation
    • Reduce fixed income holdings (if possible)
    • Rotate into inflation-protected bonds (e.g., TIPS)
fall presidential elections
Fall Presidential Elections
  • Bush/Kerry futures on IEM at 0.52/0.48
  • As is typical, business supporting Republican over Democrat
  • Proportion more lopsided toward Bush than at the end of the Bush/Gore race
  • Kerry’s “Jobs First” plan focuses on:
    • Tax incentives for companies that create jobs domestically
    • Slowing the export of jobs abroad
    • Assisting manufacturing sector

 Intends to increase taxes on wealthy

  • Bush has not outlined any significant deviations from current policies
    • Has alluded to make U.S. market less litigious (e.g., cap on malpractice awards)
  • More sensitive industries: legal, real estate, securities & investment, medical
  • Conclusion: Bush likely more favorable for global businesses; Kerry for U.S. manufacturing
sector recommendations
Sector Recommendations
  • Overweight: Financials (large cap), Energy, Industrials, Materials, IT, Consumer Discretionary
  • Neutral: Health Care, Telecom, Technology, Utilities
  • Underweight: Financials (small cap)

Consumer Staples

revisiting the question are stocks overvalued an interesting take from a value perspective
Revisiting the question: Are stocks overvalued? An interesting take from a value perspective
  • Robert Weigand and Robert Irons study suggests that high P/E ratios are no longer mean reverting or indicative of negative future returns.
  • They also find that high P/E ratios (above 21) have been associated with the highest average of 10 year earnings growth, and a positive 10 year rate of returns, going back to 1881.
  • It seems that interest rates, at least since 1960, are a better predictor of earnings and returns.
  • All of this suggests P/E ratios can deviate from the historical mean for long periods of time, or even permanently.
while p e ratios have deviated significantly from their historical mean
While P/E ratios have deviated significantly from their historical mean…

Source: Weingand & Irons, The Market P/E Ratio: Stock Returns, Earnings, and Mean Reversion

e p ratios have become cointegrated with 10 year yield
…E/P ratios have become cointegrated with 10-year Yield

Source: Weingand & Irons, The Market P/E Ratio: Stock Returns, Earnings, and Mean Reversion

e p ratios and 10 year yield what it all means for investors
E/P ratios and 10-year yield – what it all means for investors
  • The 10-year rate and E/P ratios are highly, and positively correlated, meaning that P/E ratios are negatively correlated with the 10-year yield
  • Investors should keep a close eye on interest rates
  • A bearish view on bonds means a bullish view on equities
  • Historical P/E ratios, at least for the market, are irrelevant!