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Copyright (c) 2006 Standard & Poor’s, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.
The Economic Outlook: How Hard A Landing?
David WyssChief EconomistStandard & Poor’s
NAHB Outlook ConferenceWashingtonOctober 18, 2006
2.
CONFIDENTIAL AND PROPRIETARY.
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The Recovery Is Slowing
• After a strong 2004 and 2005
• Growth has slowed to below trend.
• The economy is rotating from consumer- and housing-led growth to investment-led growth.
• The Fed is through hiking interest rates, and will probably have to reverse next year.
• The housing market peaked last summer, but is more stalling than plunging. Starts are expected to drop 25%.
• Oil prices are coming down from record highs, restoring some purchasing power.
• Katrina rebuilding has been slow.
• Stronger European growth and a weaker dollar should mean less drag from the trade deficit.
3.
CONFIDENTIAL AND PROPRIETARY.
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Another Soft Landing
Recession
GDP Growth (4 qtrs to trough)
Unemployment (trough) Change
Fed Funds (peak) Change
Treasury yield (peak) Change
Housing Starts (trough) Change
1967q2 * 2.4% 3.9% 0.3% 5.76% 4.59% 5.22% 1.07% 843 -4611970q4 -0.2% 6.1% 2.7% 9.19% 5.40% 7.91% 1.74% 1,085 -8081975q1 -2.3% 9.0% 4.4% 12.92% 9.63% 7.40% 1.12% 904 -15901980q3 -1.6% 7.8% 2.2% 17.61% 13.00% 12.75% 5.88% 927 -12701982q4 -1.4% 10.8% 3.6% 19.10% 10.07% 15.32% 1.85% 902 -6451987q1 * 2.5% 6.9% 0.3% 11.64% 3.13% 13.56% 3.18% 1,271 3291991q1 -1.0% 7.8% 2.6% 8.29% 2.38% 9.85% 3.27% 798 -8231995q4 * 2.0% 5.8% 0.4% 6.05% 3.09% 7.96% 2.63% 1,249 -3152001q4 0.2% 5.9% 2.1% 6.54% 1.91% 6.66% 2.13% 1,540 -258
* Soft Landing
4.
CONFIDENTIAL AND PROPRIETARY.
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Oil Prices Hit New Highs
0102030405060708090
1980 1985 1990 1995 2000 2005
0%1%2%3%4%5%6%7%8%9%
Oil price (WTI) 2005 dollars % of disp. income (right)
($/barrel, WTI and deflated by CPI; household energy purchases as percent of disposable income)
Source: BEA
5.
CONFIDENTIAL AND PROPRIETARY.
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The World Is More Energy Efficient
0
0.2
0.4
0.6
0.8
1
US France Germany UK Japan China India World
1971 1980 1995 2004
(Tonnes of oil equivalent per $1000 dollars (2000 dollars) of real GDP)
Source: OECD
6.
CONFIDENTIAL AND PROPRIETARY.
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0
2
4
6
8
10
1995 1997 1999 2001 2003 2005 2007 2009
Federal Funds Rate 10-Yr Bond Yield Mortgage rate
(Percent)
The Fed Is Moving Toward Neutral
Source: Federal Reserve
7.
CONFIDENTIAL AND PROPRIETARY.
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Interest Rates Had Converged
0
1
2
3
4
5
6
US Canada Japan Euro UK Australia
Oct-04 Dec-05 Oct-06
(Long-term government bonds)
Source: Bloomberg
8.
CONFIDENTIAL AND PROPRIETARY.
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Quality Spreads Grind Tighter
0100200300400500600700800900
2003 2004 2005 2006
Investment grade Speculative grade
(Spread over Treasury yields, basis points)
Source: S&P
9.
CONFIDENTIAL AND PROPRIETARY.
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Financial Risk Is Greater
0%
20%
40%
60%
80%
100%
1980 1985 1990 1995 2000 2004
AAA AA A BBB Junk
Source: S&P
10.
CONFIDENTIAL AND PROPRIETARY.
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But Corporate Debt Has Dropped
0
1
2
3
4
5
6
1993 1996 1999 2002 2005
0.4
0.5
0.6
Cash flow/debt service Debt/net worth (right)
Source: Federal Reserve Flow of Funds
11.
CONFIDENTIAL AND PROPRIETARY.
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World Growth Is Steady
0
2
4
6
8
US Canada Eurozone Japan OtherAsia
LatinAmerica
2003 2004 2005 2006 2007 2008
(Real GDP, % change)
Source: Global Insight and S&P
12.
CONFIDENTIAL AND PROPRIETARY.
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And Comes Mostly From Asia
US21%
Eurozone15%
Japan6%
Other Adv11%
China15%
India6%
East Eur7%
Other 19%
(IMF purchasing power weights, 2005)
US15%
Eurozone4%
Japan4%
Other Adv8%
China31%
India10%
East Eur9%
Other 19%
Percent of World GDP Percent of World Growth
Source: IMF
13.
CONFIDENTIAL AND PROPRIETARY.
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Fiscal Deficits Almost Everywhere
-4
-3
-2
-1
0
1
2
3
US Canada France Germ. Italy UK
(Government balance as percent of GDP, 2004)
Source: IMF
14.
CONFIDENTIAL AND PROPRIETARY.
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The Future Looks Bleak
49101
38 57 59113
173
62 86 71
350
530
182223 220
0
100
200
300
400
500
600
US Japan UK France Germany
2005 2025 2050
(Government debt as % of GDP)
Source: S&P
15.
CONFIDENTIAL AND PROPRIETARY.
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Aging Populations Will Boost Government Spending
0
10
20
30
40
50
60
US Canada France Germany Italy UK Japan AustraliaMexico OECD
2000 2020
(Ratio of over 65 population to labor force)
Source: OECD
16.
CONFIDENTIAL AND PROPRIETARY.
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US Trade Deficit Balances Surpluses Overseas
-8
-6
-4
-2
0
2
4
6
US Canada Germany France Italy UK Japan China India
(Trade balance as percent of GDP, 2005)
Source: Global Insight
17.
CONFIDENTIAL AND PROPRIETARY.
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8%10%12%14%16%18%20%22%
1970 1975 1980 1985 1990 1995 2000 2005
Gross saving Private saving Private investment
(Percent of GDP)
US Borrows From Abroad to Offset Weak Savings
Source: BEA
18.
CONFIDENTIAL AND PROPRIETARY.
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Can the Consumer Keep Spending?
• Consumer spending has led the expansion
• The tax cuts provided extra income
• Lower mortgage rates freed up funds
• Confidence is up
• But the saving rate is negative
• Tax cuts are over
• Interest rates are up
• Home prices are dropping
• Net result will be a slowdown, not a retreat
• Helped by lower energy prices
• The saving rate will remain low
19.
CONFIDENTIAL AND PROPRIETARY.
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Household Debt Hits Record As Saving Goes Negative
-2
0
2
4
6
8
10
1990 1993 1996 1999 2002 2005 2008
0.8
0.9
1
1.1
1.2
1.3
1.4
Saving rate Debt/income (right)
(Percent of after-tax income)
Source: BEA and Federal Reserve
20.
CONFIDENTIAL AND PROPRIETARY.
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More Mortgages, Fewer Credit Cards And Other Loans
50 60 70 80 90 100
1995
1998
2001
2004
Primary residence Other mortgage Installment
Credit Card Other
(Percent of household debt, 2004)
Source: Federal Reserve SCF
21.
CONFIDENTIAL AND PROPRIETARY.
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But Wealth Continues Strong, Helped By Housing Markets
0%
100%
200%
300%
400%
500%
600%
700%
1990 1993 1996 1999 2002 2005 2008
Net worth Financial assets
(Percent of after-tax income)
Source; Federal Reserve
22.
CONFIDENTIAL AND PROPRIETARY.
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0
0.5
1
1.5
2
2.5
1993 1996 1999 2002 2005 2008
10
12
14
16
18
20
Housing starts Car sales (right)
(Millions of units)
Source: Census
Higher Interest Rates Slow Car Sales And Housing Starts
23.
CONFIDENTIAL AND PROPRIETARY.
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8
10
12
14
16
18
20
22
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007
Financial Obligations Debt
Debt Service Now Above 1986 Record
(Household obligations as percent of after-tax income)
Source: Federal Reserve
24.
CONFIDENTIAL AND PROPRIETARY.
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Debt Repayments Are Evenly Distributed
0
4
8
12
16
20
0-20 20-40 40-60 60-80 80-90 90-100
1995 2004
(Average debt repayment as percent of income by income percentile)
Source: SCF
25.
CONFIDENTIAL AND PROPRIETARY.
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The Rich Have Mortgages, The Poor Have Credit Cards
0102030405060708090
0-20 20-40 40-60 60-80 80-90 90-100
Mortgage Installment Credit card
(Percentage of households with debt owed)
Source: SCF
26.
CONFIDENTIAL AND PROPRIETARY.
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A Housing Bubble?
• Housing remains affordable
• Thanks to low mortgage rates
• But what happens when rates go up?
• Home prices have outpaced incomes
• Ratio of home price to income is at a record high
• There are big local bubbles
– E.g., New York, California, Boston, Florida
• And higher mortgage rates will cause starts and sales to drop
• Housing looks less overvalued than other assets
27.
CONFIDENTIAL AND PROPRIETARY.
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More Affordable Housing Allows Households To Own Homes
0.60
0.80
1.00
1.20
1.40
1.60
1980 1983 1986 1989 1992 1995 1998 2001 2004
60
62
64
66
68
70
Homeownership Rate (Right scale) Affordability (Left scale)
Source: Census Bureau
28.
CONFIDENTIAL AND PROPRIETARY.
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Home Prices Are High Relative to Household Income
2
2.5
3
3.5
4
4.5
1975 1979 1983 1987 1991 1995 1999 2003 2007
Existing New Quality-adjusted
(Ratio of average home price to average household disposable income)
Source: BEA
29.
CONFIDENTIAL AND PROPRIETARY.
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Bubbles Are Everywhere
-100 -50 0 50 100 150 200 250
Hong KongNewZealan
China*Australia
JapanSpain
FranceSweden
ItalyIrelandBritain
NetherlandSwitzerland
GermanyCanada
US
(Percent increase in home prices, 1997-2005)
(* Based on 2 years’ of data)
Source: The Economist
30.
CONFIDENTIAL AND PROPRIETARY.
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The Most Expensive Cities
Source: Census; 2005 data
Median House
Price
Median Household
IncomePrice/Income
Ratio
San Diego-Carlsbad-San Marcos, CA 604.3 43.3 14.0Los Angeles-Long Beach-Santa Ana, CA 691.9 51.8 13.4San Francisco-Oakland-Fremont, CA 715.7 56.3 12.7San Jose-Sunnyvale-Santa Clara, CA 744.5 65.4 11.4Honolulu, HI 590.0 60.5 9.8Miami-Fort Lauderdale-Miami Beach, FL 371.1 43.1 8.6New York-Northern New Jersey-Long Island, NY-NJ-PA 446.5 56.1 8.0Riverside-San Bernardino-Ontario, CA 374.2 50.8 7.4Reno-Sparks, NV 349.9 49.0 7.1Seattle-Tacoma-Bellevue, WA 316.8 44.5 7.1
($ thousand)
31.
CONFIDENTIAL AND PROPRIETARY.
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The Stock Market Will Recover, But Slowly
• Market rose over 20%/year from 1995 -99
• But dropped from March 2000 through June 2003
• Biggest drop since 1929-32
• Double-digit earning gains for a record 17 quarters; profits are a record high relative to GDP
• Earnings must slow
• Share prices cannot continue to outpace earnings
• As interest rates rise
• Stocks will thus yield less in the future than in the recent past.
• But the current rally is being spurred by strong earnings and dividend tax cuts
32.
CONFIDENTIAL AND PROPRIETARY.
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Most US Sectors Have Recovered From The Bear Market
-100 -75 -50 -25 0 25 50 75 100
S&P 500
Cons Discr
Cons Staples
Energy
Financials
Health Care
Industrials
Technology
Materials
Telecomm
Utilities
Oct-02 Sep-06
(Change in S&P 500 sectors since March 24, 2000 peak)
Source: S&P
33.
CONFIDENTIAL AND PROPRIETARY.
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Bottom Line: The Economy Recovers, But Slowly
• Consumers are spending their max
• Businesses are taking over the lead
• But fiscal policy stimulus is over
• Interest rates are up
• Weak recovery for stock market
• Risk of recession remains if:
– Further terror attacks damage confidence, while oil prices soar
– Problems in financing deficits push investment down and savings up
• But could be better if productivity stays stronger
34.
CONFIDENTIAL AND PROPRIETARY.
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Risks to the Economy
-2%
0%
2%
4%
6%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Baseline Pessim Optim
(Real GDP, percent change year ago)
Source: BEA, S&P projections
35.
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36.
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