THE ECONOMY AND THE THE ECONOMY AND THE CAPITAL MARKETSCAPITAL MARKETS

University of ConnecticutSchool of Business

Robert F. DeLuciaMarch 26, 2004

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AGENDA

Introduction and Overview

Identifying Critical Economic Forces

Economic Outlook Summary

Broad Capital Market Implications

In-Depth Equity Market Analysis

Equity Market Valuation Factors

Major Systematic Risks to the Forecasts

Individual Stock Selection

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INTRODUCTION

CIGNA Retirement & Investment Services

Prudential Retirement

Economic Function and Mission

Philosophy and Methodology

Investment vs. Speculation

Emphasis on Economic Fundamentals

Emphasis on Government Economic Policy

Intrinsic Value Foundation

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PRIMARY ECONOMIC FORCES

Unprecedented Federal Reserve Monetary Stimulus

Pro-Growth / Pro-Investment Tax Policy

Transformation of the U.S. Corporate Sector Balance Sheet, Finances, and Profitability

Declining U.S. Dollar Exchange Rate

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OTHER SIGNIFICANT ECONOMIC FORCES

Global Central Bank Monetary Stimulus, Particularlyin Asia

Rapid Pace of Technological Innovation

Unprecedented Growth in Labor Productivity

Highly Favorable Credit Market Conditions

Globalization and Increasingly Free Markets

Asian Economic Boom Led by Industrialization of China

Schumpeterian Waves of “Creative Destruction”

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ECONOMIC OUTLOOK: MAJOR CONCLUSIONS

Above-Trend Economic Growth 2004 – 2005

Economic Sector Leadership: Capital Goods, Exports, and Basic Manufacturing

Continued Rising Corporate Profitability

Mild Acceleration in Inflation 2004 – 2005

Global Economic Recovery

Steadily Rising Interest Rates Beginning in Second Half of 2004 and well into 2005

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CAPITAL MARKET IMPLICATIONS: SUMMARY

Economic Trends and Policy Remain Favorable for Equity Markets

Bear Market for Fixed Income During 2004 – 2005 Period

Further Dollar Depreciation, Primarily Against the Asian Currencies

Within Equity Markets, Most Favorable:

Large Capitalization Stocks

Highest Quality Industry Leaders

Favorable Dividend Prospects

U.S. Multinationals

Non-Dollar Markets and Emerging Asia

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EQUITY MARKET ANALYSIS: BASIC PRINCIPLES

Corporate Sector Fundamentals

Earnings, Cash Flow, Dividends

Balance Sheets

Corporate Governance

Equity Market Valuation

Quantitative Factors

Qualitative Factors

In Short: Ability of Corporations to Grow Earnings and Dividends, and Market Capitalization Factors

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EQUITY MARKET VALUATION FACTORS:CAPITALIZATION RATES

Inflation

Interest Rates

Liquidity / Yield Curve / Federal Reserve Policy

Tax Policy

U.S. Dollar

Dividend Pay-Out Ratios

Quality of Reported EPS

Stability of Economic Growth

Geopolitical Developments

Government Economic Policies

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EQUITY MARKET VALUATION, INTEREST RATES, AND INFLATION

Average P/E Ratio

Average Annual

CPI

Market Yield10-Year

Treasury Note

1960 - 1972 17.0 x + 2.8% 5.25%

1973 - 1984 9.5 + 8.0 9.75

1985 - 1996 15.5 + 3.5 7.75

1997 - 2003 24.0 + 2.3 5.25

1960 - 2003 Average 16.0 x + 4.3% 7.25%

Current Market 18.0 x + 1.7% 3.75%

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MAJOR RISKS TO THE OUTLOOK

The War on Terrorism

Geopolitical / Middle East Instability

Energy Supply / Costs

Rising Inflation Leads to Premature Monetary Squeeze

U.S. Dollar / Foreign Exchange Crisis

Bond Market Collapse

Trade Protectionism

Boom / Bust Cycle in China

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SUMMARY AND MAJOR CONCLUSIONS

Prevailing Government Economic Policies and Business Cycle Forces Favorable for Equity Markets

Bonds are in Early Phase of a Multi-Year Bear Market

Further U.S. Dollar Depreciation Likely 2004 – 2005

Equity Market is No Longer Cheap but also Not Statistically Overvalued

Regional and Market Sector Opportunities Exist

Individual Stock Selection More Important Than Ever