Smith Breeden Associates
description
Transcript of Smith Breeden Associates
Smith Breeden Associates
Macroeconomic Outlook
May 12, 2003
Eugene F. Flood, President and CEO
Macroeconomic Outlook
• Historically unusual economic times• Suppose we assume the recovery began
January 2002• Industrial production at bottom end of
historical experience
Industrial Production Growth During Recession and RecoveryThin Lines are Peak to Trough (NBER Recession)
Thick Lines are Trough to + 14 months
-5.00%
-4.00%
-3.00%
-2.00%
-1.00%
0.00%
1.00%
2.00%
3.00%
4.00%
Feb-
53
Feb-
55
Feb-
57
Feb-
59
Feb-
61
Feb-
63
Feb-
65
Feb-
67
Feb-
69
Feb-
71
Feb-
73
Feb-
75
Feb-
77
Feb-
79
Feb-
81
Feb-
83
Feb-
85
Feb-
87
Feb-
89
Feb-
91
Feb-
93
Feb-
95
Feb-
97
Feb-
99
Feb-
01
Feb-
03
Mon
thly
gro
wth
R53 R53+14 R57 R57+14 R60 R60+14 R69 R69+14 R75 R75+14R80 R80+14 R81 R81+14 R90 R90+14 R01 R01+15
Industrial Production Growth During RecoveryTrough to Trough +14 Months
-1.00%
-0.50%
0.00%
0.50%
1.00%
1.50%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Mon
thly
gro
wth
R01+15 Average 9 recessions Average 6 recessions
Macroeconomic Outlook
• We have heard the term “jobless” recovery• Current experience is very unusual
Change in Nonfarm Payrolls During Recession and RecoveryThin Lines are Peak to Trough (NBER Recession)
Thick Lines are Trough to + 12 months
-80000.00%
-60000.00%
-40000.00%
-20000.00%
0.00%
20000.00%
40000.00%
60000.00%
80000.00%
100000.00%
120000.00%
140000.00%
Feb-5
3
Feb-5
5
Feb-5
7
Feb-5
9
Feb-6
1
Feb-6
3
Feb-6
5
Feb-6
7
Feb-6
9
Feb-71
Feb-7
3
Feb-7
5
Feb-7
7
Feb-7
9
Feb-8
1
Feb-8
3
Feb-8
5
Feb-8
7
Feb-8
9
Feb-9
1
Feb-9
3
Feb-9
5
Feb-9
7
Feb-9
9
Feb-0
1
Feb-0
3
Mon
thly
gro
wth
R53 R53+14 R57 R57+14 R60 R60+14 R69 R69+14 R75 R75+14R80 R80+14 R81 R81+14 R90 R90+14 R01 R01+15
Change in Nonfarm Payrolls During RecoveryTrough to Trough +14 Months
-400
-300
-200
-100
0
100
200
300
400
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Mon
thly
gro
wth
R01+15 Average 9 recessions Average 6 recessions
Percentage Change in Nonfarm Payrolls During RecoveryTrough to Trough +14 Months
-0.40%
-0.30%
-0.20%
-0.10%
0.00%
0.10%
0.20%
0.30%
0.40%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Mon
thly
gro
wth
R01+15 Average 9 recessions Average 6 recessions
Macroeconomic Outlook
• Employment gap:Jobs created since January 2002 = -594,000Jobs usually created in recovery = 1,473,000Gap = 2,000,000 jobs
• Insufficient capital spending – at levels of seven years ago
New Orders for Nondefense Capital Goods Scaled by PPI
0
10,000
20,000
30,000
40,000
50,000
60,000
Feb-92
Feb-93
Feb-94
Feb-95
Feb-96
Feb-97
Feb-98
Feb-99
Feb-00
Feb-01
Feb-02
Feb-03
Mill
ions
$
Nondefense Nondefense x aircraft
Macroeconomic Outlook
Why?• Largely a result of uncertainty induced by
geopolitical risk
ICRG Political Risk
Data from PRS
60
65
70
75
80
85
90
95
100
Equally-weighted world G-7xUS Switzerland United States
Macroeconomic Outlook
ICRG Political Risk
Data from PRS
60
65
70
75
80
85
90
95
100
Equally-weighted world Japan Switzerland United States
Macroeconomic Outlook
ICRG Political Risk
Data from PRS
6065707580859095
100
Equally-weighted world JapanGermany SwitzerlandUnited States
Macroeconomic Outlook
Macroeconomic Outlook
• Corporations have acted defensively on two fronts:– Option to wait is very valuable– Employment retrenchment
Macroeconomic Outlook
• Recent FEI/Duke University survey showed 67% of CFOs had were being very cautious or putting capital spending “on hold”
Macroeconomic Outlook
• Some mitigation of political risk with the short war in Iraq
• Will lead to a boost in consumer confidence and some increases in employment (reversing the retrenchment of the last six months)
Recent blip in consumer confidence
50
60
70
80
90
100
110
Michigan survey
Macroeconomic Outlook
Macroeconomic Outlook
• However, investors realize that the resolution of the war is not that simple
• There is still considerable uncertainty about the political landscape in Iraq and the surrounding countries.
Macroeconomic Outlook
• Fiscal stimulus unlikely to have a material effect in 2003
• There is enough disagreement on the logic of the tax cut that positive effects will likely be muted
Macroeconomic Outlook
• Monetary policy has been consistent• Fed increasingly aware of risk of deflation
– Deflation is a problem because it gives consumers and corporations the incentive to delay their purchases (until prices cheaper)
Macroeconomic Outlook
• Federal Reserve is willing to make one final cut in rates if they perceive the economic risk increasing over the next few months
Macroeconomic Outlook
• Insert graph of cuts in rates
Macroeconomic Outlook
• However, there is unlikely to be much impact from cutting rates from a historical low of 125bp to another historical low of 75bp
Macroeconomic Outlook
• Other downsides:– Might be perceived as a desperate move– Exercising an option that cannot be exercised
again (even if it is really needed)– Specter of Japan comparisons– Further erosion in dollar might damage
business confidence (even though exports become more competitive)
Macroeconomic Outlook
• Globalization will not help the U.S. recovery – this time around:– “International diversification” of world
economies only works when business cycles out of phase.
– For example, if U.S. goes into recession but Japan and Germany are experiencing high growth, then a U.S. recovery can be export driven.
Macroeconomic Outlook
• Japan has been in trouble for 14 years• Slowly deflating bubble• Unwilling to face up to the crisis in
financial institutions• 100 Enrons
Macroeconomic Outlook
• Germany paying the price of the Euro• If the DMark was still around, the
Bundesbank would have slashed rates further than the ECB has
Macroeconomic Outlook
• Don’t expect much from the stock market• Historically, the average return on the S&P
500 has been 9% above the Treasury bill rate (January 1926-December 2002). This is called the “risk premium”
Macroeconomic Outlook
• Duke-FEI survey of CFOs over the past three years shows much different expectations
One-Year Forecast• One-year risk premium quite variable. Currently,
about 3.25%
0123456
6-Jun-00 7-Sep-00 4-Dec-00 12-Mar-017-Jun-01 10-Sep-01 4-Dec-01 11-Mar-024-Jun-02 16-Sep-02 4-Dec-02 19-Mar-03
Macroeconomic Outlook
Ten-Year Premium• Ten-year risk premium is stable. Currently,
about 3.75%
0123456
6-Jun-00 7-Sep-00 4-Dec-00 12-Mar-017-Jun-01 10-Sep-01 4-Dec-01 11-Mar-024-Jun-02 16-Sep-02 2-Dec-02 19-Mar-03
Macroeconomic Outlook
Conclusions• To be added
Macroeconomic Outlook