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Member FINRA/SIPC
The Economy and Financial Markets
February 22, 2008
2
The Economy and Financial Markets
Member FINRA/SIPC
Economy and Financial Markets:Current Conditions
Economy strong in Q3, slow in Q4 and Q1.
Inflation contained – core around 2-2.5%.
Profits / Earnings big short-term hit – sub prime related.
Stock price gains in 08 expected to match earnings growth.
Risks are: terrorism, Iraq, oil prices and subprime reaction.
Bond market risk moderate due to good inflation outlook.
Credit market concerns appear overblown, damage limited.
$ exchange rate bouncing off a new record low.
3
The Economy and Financial Markets
Member FINRA/SIPC
Quarterly % Change in Real GDP % Change - Annual Rate
12-Month % Change in Payroll Employment % Change - Year to Year
0500959085
Sources: BEA, BLS /Haver 02/22/08
12
8
4
0
-4
-8
12
8
4
0
-4
-8
Q3 GDP Up 4.9%, Q4 +0.6% (Lower Due to Housing & Inventory Drop), Employment Growth +0.7%
4
The Economy and Financial Markets
Member FINRA/SIPC
ECRI Weekly Leading Index1992=100
Dow Jones U.S. Business Barometer Index2000=100
05009590Sources: ECRI, BTMU /Haver 02/22/08
160
140
120
100
80
104
100
96
92
88
84
80
ECRI and Dow Barometer Down, Expect Slowdown, Not Recession
5
The Economy and Financial Markets
Member FINRA/SIPC
Real After-Tax Personal IncomeSAAR, Bil.Chn.2000$
Real Personal Consumption ExpendituresSAAR, Bil.Chn.2000$
05009590Source: Bureau of Economic Analysis /Haver Analytics 02/22/08
9000
8250
7500
6750
6000
5250
4500
9000
8250
7500
6750
6000
5250
4500
Real Personal Income Rising, as is Spending: Not Much Housing Impact
6
The Economy and Financial Markets
Member FINRA/SIPC
Shipments of Manufacturing Durable GoodsSA, Mil.$
New Orders for Manufacturing Durable GoodsSA, Mil.$
05009590Source: Census Bureau /Haver Analytics 02/22/08
250000
225000
200000
175000
150000
125000
100000
250000
225000
200000
175000
150000
125000
100000
New Orders Surge But Shipments Still Flat – Business Cost Control
7
The Economy and Financial Markets
Member FINRA/SIPC
Unfilled Orders for Durable Goods: Order Backlog Very HighSA, Mil.$
Ratio of Inventories to Shipments: Low - No Inventory OverhangRatio
05009590Source: Haver Analytics 02/22/08
825000
750000
675000
600000
525000
450000
375000
2.4
2.2
2.0
1.8
1.6
1.4
1.2
Order Backlog Very High, Inventories Low Relative to Shipments
8
The Economy and Financial Markets
Member FINRA/SIPC
Median Sales Price: Existing 1-Family Homes$
Ratio: Median Price / Disposable Income per CapitaMeasure of housing P/E
0500959085807570Source: Haver Analytics 02/22/08
240000
200000
160000
120000
80000
40000
0
8.0
7.5
7.0
6.5
6.0
5.5
5.0
Home Prices Weak, Income Up So Housing “P / E” Now Way Down (Especially Given Low Interest Rates)
9
The Economy and Financial Markets
Member FINRA/SIPC
Housing StartsSAAR, Thous.Units
New Single Family Home SalesSAAR, Thous
05009590Source: Census Bureau /Haver Analytics 02/22/08
2400
2000
1600
1200
800
400
1400
1200
1000
800
600
400
Home Sales and Starts Now Way Down – After 2 Years of Decline, The Worst Likely Behind Us.
10
The Economy and Financial Markets
Member FINRA/SIPC
Loan Delinquency Rate: All Commercial BanksSA,%
Loan Charge-Off Rate: All Commercial BanksSA,%
0500959085
Source: Federal Reserve Board /Haver Analytics 02/22/08
7
6
5
4
3
2
1
0
7
6
5
4
3
2
1
0
Major Credit Threat? No – Total Bank Problem Loans Low. Q4 Residential Loan Delinquency 3.1%, Defaults 0.4%, Low, But Likely to Rise
11
The Economy and Financial Markets
Member FINRA/SIPC
Growth in Real U.S. Exports % Change - Year to Year
Growth in Real U.S. Imports % Change - Year to Year
080706050403020100999897969594Source: Bureau of the Census /Haver Analytics 02/22/08
20
10
0
-10
-20
20
10
0
-10
-20
US Trade Upturn Offsets Housing Weakness. U.S. Exports Are Three Times As Big As Residential Construction.
12
The Economy and Financial Markets
Member FINRA/SIPC
Unemployment RateSA, %
Weekly Initial Claims for Unemployment InsuranceSA, Thous
05009590Sources: BLS, DOL /Haver 02/22/08
8.25
7.50
6.75
6.00
5.25
4.50
3.75
600
525
450
375
300
225
Claims Lead Unemployment Rate (4.9%), Claims Are Up Some, So Unemployment May Drift a Bit Higher.
13
The Economy and Financial Markets
Member FINRA/SIPC
Change in Total Employment Cost Index (Wages + Benefits)Private Sector: 4-Quarter % Change
Change in Benefits Cost - Has Slowed Considerably4-Quarter % Change
05009590
Source: Bureau of Labor Statistics /Haver Analytics 02/22/08
8
7
6
5
4
3
2
1
8
7
6
5
4
3
2
1
Private Sector Employment Cost Inflation at 3% - Benefit Costs Under Control
14
The Economy and Financial Markets
Member FINRA/SIPC
Total CPI Inflation % Change - Year to Year
Core CPI Inflation (Excludes Food & Energy % Change - Year to Year
05009590Source: Bureau of Labor Statistics /Haver Analytics 02/22/08
7
6
5
4
3
2
1
7
6
5
4
3
2
1
Total CPI Inflation Up Due to Oil Prices, Core Still Down at 2.4%
15
The Economy and Financial Markets
Member FINRA/SIPC
Fed Funds Target RateEOP, %
Sum of Core CPI Inflation and Payroll Employment Growth%
05009590Source: Haver Analytics 02/22/08
10
8
6
4
2
0
10
8
6
4
2
0
Fed Target is (Roughly) Core Inflation + Employment Growth. We Think Rate Cuts are the Right Policy Action
Fed funds rate finally below the 3.2% sum of core CPI inflation of 2.5% and job growth of 0.7%.
Fed over did it in late 1999 - 2000
16
The Economy and Financial Markets
Member FINRA/SIPC
Crude Oil Price - West TexasEOP, $/Barrel
Dollar Exchange Rate - Major Currency IndexAvg, 3/73=100
05009590Sources: WSJ, FRB /Haver 02/22/08
120
100
80
60
40
20
0
112.5
105.0
97.5
90.0
82.5
75.0
67.5
Risks? Sure – Sky High Oil Prices & Lack of Dollar Rebound
Record Dollar lows behind us?
Record oil price behind us?
17
The Economy and Financial Markets
Member FINRA/SIPC
S&P 500: After-tax Earnings with Next Quarter Estimate$/Shr
S&P 500: Operating Earnings with Next Qtr Estimate$/Share
05009590
Source: Standard & Poor's /Haver Analytics 02/22/08
24
20
16
12
8
4
0
28
24
20
16
12
8
4
Company Earnings Outside Financials Okay, but Big Q3-Q4 Hit on Financials From the Sub-Prime Fiasco.
18
The Economy and Financial Markets
Member FINRA/SIPC
P/E Ratio: S&P 500 Stock Price Divided By Same Quarters Earnings
P/E calculated using current quarter operating earnings times 4
05009590
Source: Haver Analytics 02/22/08
0.35
0.30
0.25
0.20
0.15
0.10
0.35
0.30
0.25
0.20
0.15
0.10
Current Quarter S&P 500 P / E is around 22 – Spike Due to Subprime Hit Higher Risk on the Value Side, Lower Risk on the Growth Side
Higher Risk Region
Lower Risk Region
19
The Economy and Financial Markets
Member FINRA/SIPC
US Net New Equity Issues: Record High Stock Buybacks!
New Equity Issued less Stock Bought Back in $Billions at Annual Rates
050095908580757065605550
Source: Haver Analytics 02/22/08
200
0
-200
-400
-600
-800
200
0
-200
-400
-600
-800
Record U.S. Net Stock Repurchases - $610 Billion Last Four Quarters
20
The Economy and Financial Markets
Member FINRA/SIPC
Financial Assets Less Liabilities of All US Nonfinancial Corps.
billions - US companies are now net lenders
0500959085807570656055
Source: Haver Analytics 02/22/08
1500
1000
500
0
-500
-1000
-1500
1500
1000
500
0
-500
-1000
-1500
Corp. Balance Sheet – Companies’ Financial Assets Exceed Liabilities by $1.4 Trillion. Now Net Lenders, Usually are Net Borrowers
Total U.S. non-financial companies net lenders
Total U.S. non-financial companies net borrowers
21
The Economy and Financial Markets
Member FINRA/SIPC
Equity Total Return Beats Fixed Income, but with Volatility
S&P 500 Total ReturnEOMLehman Bond Index: US Aggregate Total ReturnEOP, Dec-31-75=10005009590 Sources: Standard & Poor's, Lehman Brothers/ Haver Analytics 02/22/0825002000150010005000 25002000150010005000
22
The Economy and Financial Markets
Member FINRA/SIPC
Total Return: Russell 3000 Value Index5/31/95=1000
Total Return: Russell 3000 Growth Index5/31/95=1000
0807060504030201009998979695Source: Frank Russell Company /Haver Analytics 02/22/08
4500
3750
3000
2250
1500
750
4500
3750
3000
2250
1500
750
Value Has Outperformed Growth Since 2000 – is Now Reversing
23
The Economy and Financial Markets
Member FINRA/SIPC
Cumulative Total Return of Value Relative to Growth
Ratio: Russell 3000 Value / Growth Total Return Indices
050095908580Source: Haver Analytics 02/22/08
1.8
1.6
1.4
1.2
1.0
0.8
0.6
1.8
1.6
1.4
1.2
1.0
0.8
0.6
About 110% Outperformance of Value Since 2000 Now Reversing
24
The Economy and Financial Markets
Member FINRA/SIPC
Total Return: Russell 1000 Large Cap IndexAvg, 12/31/78=100
Total Return: Russell 2000 Small Cap IndexAvg, 12/31/78=100
080706050403020100999897969594Source: Frank Russell Company /Haver Analytics 02/22/08
4500
3750
3000
2250
1500
750
4500
3750
3000
2250
1500
750
Small Caps Outperformed Large Caps Since 1999 – Now Reversing
25
The Economy and Financial Markets
Member FINRA/SIPC
Cumulative Total Return of Small Relative to Large Caps
Ratio: Russell 2000 / Russell 1000 Total Return Indices
050095908580Source: Haver Analytics 02/22/08
1.6
1.4
1.2
1.0
0.8
0.6
0.4
1.6
1.4
1.2
1.0
0.8
0.6
0.4
Last 28 Years Small Caps have NOT Outperformed Large Caps. Back to Underperforming
26
The Economy and Financial Markets
Member FINRA/SIPC
EAFE Total Return Index in DollarsEOP US$
S&P 500 Total ReturnEOP
050095908580Sources: MSCI Inc. , Standard & Poor's /Haver Analytics 02/22/08
8000
6000
4000
2000
0
8000
6000
4000
2000
0
Large Cap International Equities (EAFE Index) Now Underperforming The U.S.
27
The Economy and Financial Markets
Member FINRA/SIPC
30-Year Treasury Bond YieldAvg,%
2-Year Treasury Note YieldAvg, %
05009590Sources: Haver Analytics, U.S. Treasury 02/22/08
10
8
6
4
2
0
10
8
6
4
2
0
Fast, Deep Short-term Rate Cuts Sharply Lower Recession Probability. Low Long-term Rates Help.
28
The Economy and Financial Markets
Member FINRA/SIPC
High Yield RateSource: Merrill Lynch
Yield Spread: High Yield Rate Less 5-Year Treasury Rate%
08070605040302010099989796Source: Haver Analytics 02/22/08
15.0
12.5
10.0
7.5
5.0
2.5
0.0
15.0
12.5
10.0
7.5
5.0
2.5
0.0
High Yield – Spreads Up On Sub Prime Worries
29
The Economy and Financial Markets
Member FINRA/SIPC
Ratio: Russell 3000 Value to Russell 3000 Total Return IndicesMeasures cumulative total return of Value relative to the Total market
Ratio: Russell 3000 Growth to Russell 3000 Total Return IndicesMeasures cumulative total return of Growth relative to the Total market
050095908580Source: Haver Analytics 02/22/08
1.3
1.2
1.1
1.0
0.9
0.8
0.7
1.3
1.2
1.1
1.0
0.9
0.8
0.7
Shark Chart: Return of Value & Growth Relative to Total Market
30
The Economy and Financial Markets
Member FINRA/SIPC
Conclusions
GDP growth for 08 expected to be in the 2% range.
$80+ oil knocks 1-2%+ off GDP & cut jobs gain by a million.
Total inflation up on oil prices, but core inflation remains low.
Earnings are generally okay – expect 5-10% in 2008.
S&P 500 P/E spiking up, but expect prices to track 08 earnings.
Non-Financial Co. Earnings and Balance Sheet quality look high.
Bond risk moderate, subprime problems concentrated.
Dollar exchange rate risk now low (recovering from record low).
Further fed funds rate cut to 2.5% likely.
31
The Economy and Financial Markets
Member FINRA/SIPC
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Russell 1000 Index measures performance of 1000 large cap, US companies. The Russell 2000 Index measures performance of 2000 small cap, US companies. The Russell 3000 Growth and Value Indices measure the performance of growth and value stocks respectively.
The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries, and widely held by individuals and institutional investors. These 30 stocks represent about a fifth of the $8 trillion-plus market value of all U.S. stocks and about a fourth of the value of stocks listed on the New York Stock Exchange. It is not possible to invest directly in an index.
The Lehman Brothers Aggregate Bond Index is composed of securities from the Lehman Government/Credit Bond Index, Mortgage Backed Securities Index and Asset Backed Securities Index.
The Merrill Lynch High Yield Index is an unmanaged index consisting of bonds that are issued in U.S. Domestic markets with at least one year remaining maturity. All bonds must have a credit rating below investment grade but not in default.
Government bonds and Treasury Bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.
High yield/junk bonds are not investment grade securities, involve substantial risks and generally should be part of the diversified portfolio of sophisticated investors.
Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments.
P/E Multiple: A tool for comparing the prices of different common stocks by assessing how much the market is willing to pay a share of each corporation’s earnings. It is calculated by dividing the current market price of a stock by the earnings per share.
Past performance is no guarantee of future results. Indices such as the S&P 500 may not be invested into directly.
The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing.
The Morgan Stanley Capital International (“MSCI”) Europe, Australasia, Far East Index (“EAFE”) is an unmanaged index of over 900 companies, and is a generally accepted benchmark for major overseas markets. Index weightings represent the relative capitalizations of the major overseas makers included in the index on a U.S. dollar adjusted basis. The index is calculated separately; without dividends, with gross dividends reinvested and estimated tax withheld, and with gross dividends reinvested, in both U.S. Dollars and local currency.
Important Disclosures
This research material has been prepared by LPL Financial. The LPL Financial family of affiliated companies includes LPL, UVEST Financial Services Group, Inc., IFMG Securities, Inc., Mutual Service Corporation, Waterstone Financial Group, Inc., and
Associated Securities Corp., each of which is a member of FINRA/SIPC.
Not FDIC/NCUA Insured Not Bank/Credit Union Guaranteed May Lose Value
Not Guaranteed by any Government Agency Not a Bank/Credit Union Deposit
Tracking# 396827 (Exp 12/08)