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US Economic and Capital Markets Outlook

US Economic and Capital Markets Outlook. May 3, 2005. NFSA 100 th Anniversary. Giulio Martini Chief Investment Officer— Currency and Quantitative Strategies. Recent US Economic Momentum Is Sustainable. Liquidity* Flows vs. Real GDP Growth. (YoY % chg). Liquidity Flows. Real GDP Growth.

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US Economic and Capital Markets Outlook

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  1. US Economic and Capital Markets Outlook May 3, 2005 NFSA 100th Anniversary Giulio MartiniChief Investment Officer— Currency and Quantitative Strategies

  2. Recent US Economic Momentum Is Sustainable Liquidity* Flows vs. Real GDP Growth (YoY % chg) Liquidity Flows Real GDP Growth *Liquidity is a measure of real money growth, growth in business and consumer credit, growth in short-term liquid assets, foreign purchases of US securities, net cash flow into bond and stock funds Source: Bureau of Economic Analysis, Haver Analytics and Alliance Capital Fixed Income

  3. Inventory Rebuilding Still Lags Final Demand Real Final Sales vs. Real Inventory Positions Final Sales Inventory Positions Source: Bureau of Economic Analysis, Haver Analytics and Alliance Capital Fixed Income

  4. Investment Is Key Driver of Economic Growth 2004 Real GDP Growth Imports Real GDP Structures Source: Bureau of Economic Analysis, Haver Analytics and Alliance Capital Fixed Income

  5. Nonresidential Construction Usually Rises Steadily Index Average of 5 expansions 1991 Quarters from Trough Source: US Department of Commerce, Haver Analytics and AllianceBernstein

  6. 1991 Recovery Was Weaker and More Gradual Index Average of 5 expansions 1991 1991 Quarters from Trough Source: US Department of Commerce, Haver Analytics and AllianceBernstein

  7. Current Recovery Very Modest Index Average of 5 expansions 1991 Current Expansion Quarters from Trough Source: US Department of Commerce, Haver Analytics and AllianceBernstein

  8. Sprinklers Defy Construction Trend Annualized Growth: 1980–2004

  9. Employment and Income Trends Are Improving Payroll and Household Employment (Year-over-Year Change) Disposable Income vs. Wages (Year-over-Year Change) Wage & Salary Income Payroll Employment Household Employment Disposable Income Source: Bureau of Economic Analysis, Bureau of Labor Statistics and Haver Analytics

  10. Personal Saving at All-Time Low, But Wealth at Record Levels Personal Saving Rate Household Net Worth Source: Bureau of Economic Analysis, Federal Reserve Board and Haver Analytics

  11. Housing Market Supported By Strong Fundamentals Home Sales and Affordability Rates vs. Prices Housing Affordability (right scale) Mortgage Rate House Price Index (YoY % chg) Existing-Home Sales (left scale) Source: Federal Housing Finance Board, Office of Housing Enterprise Oversight, National Association of Realtors, Haver Analytics and Alliance Capital Fixed Income

  12. Housing Starts Are Strong and Inventories Are Low Housing Starts Month’s Supply of New Homes at Current Sales Rate January 2005 Source: Census Bureau and Haver Analytics

  13. War Chest of Free Cash Flow; Bright Capital Spending Outlook Net Cash Flow vs. Business Investment in Equipment and Software Ratio of Free Cash Flow* to Capital Spending ($ Billions) Cash Flow $287 Billion WOW!! Investment *Three-year sum. Source: Bureau of Economic Analysis, Haver Analytics and Alliance Capital Fixed Income

  14. Strong Capex Cycle Is Underway, and It’s Broad Based 2004 Business Spending on Equipment and Software (Year-over-Year Percent Change) 12-Month Dollar Change in Order Backlogs: February 2005 ($ Billions) Total Source: Census Bureau, Bureau of Economic Analysis, Haver Analytics and Alliance Capital Fixed Income

  15. Trade Deficit Is Large and Structural in Nature Imports As a Percent of Domestic Shipments Trade Deficit Source: Department of Commerce, Haver Analytics and Alliance Capital Fixed Income

  16. US Runs a Deficit in Every Product Category With Every Region 2004 US Trade Deficit Composition By Product By Region Latin America 6% North America 17% Industrial Supplies 7% Autos 22% OPEC* 11% Miscellaneous 2% Other 5% Capital Goods 2% Agricultural Goods 1% Petroleum 25% Western Europe 17% Consumer Goods 41% Pacific Rim 44% Through November 2004 *Includes Venezuela and Indonesia. Source: Department of Commerce

  17. US Relies on Foreign Capital To Fund Its Investment Needs Current Account Balance As a Percent of GDP Savings and Investment as a Percent of GDP Investment Current Account Imbalance Savings F Source: International Monetary Fund Haver Analytics and Alliance Capital Fixed Income

  18. Foreign Capital Flows into US Are Strong, Especially From Asia Foreign Purchases of US Financial Assets (4-Quarter Moving Average) Savings and Investment of Newly Industrialized Asian Economies as a Percent of GDP Total Savings Private Investment Official F Source: International Monetary Fund

  19. Foreigners Have Lost Interest in US Equity Investments… Plant, Equipment,etc. Stocks $321 Bil. $194 Bil. $163 Bil. $33 Bil. 2000 2004 Source: Federal Reserve Board Flow of Funds

  20. …and Have Turned to Bonds Fixed Income $1,019 Bil. Fed Funds & Other Agency Plant, Equipment,etc. $282 Corporate Stocks $321 Bil. $194 Bil. $163 Bil. $371 Government $33 Bil. 2000 2004 Source: Federal Reserve Board Flow of Funds

  21. Foreign Ownership of US Financial Assets Growing US Treasury Bonds Fed Funds (Overnight Liquidity) US Corporate Bonds Stocks Owned byForeigners 11% 24% 42% 46% December 2004 Source: Federal Reserve Board

  22. 87 83 76 Real-Dollar Exchange Rate Still Above Prior Lows Real Trade-Weighted Dollar Index Mar 73=100 Through March 31, 2005Source: Federal Reserve Board and Haver Analytics

  23. Growth in Oil Demand Met Largely by Former Soviet Union (FSU) Sources of New Supply(Million Barrels per Day) 6.5 OPEC All Other FSU 1999–2004 Source: BP Statistical Review, International Energy Agency (IEA), OPEC, and Bernstein

  24. Russian Output Growth Not Based on New Discoveries Reserve Discoveries vs. Production Discoveries(Bil. bbl) Production(Mil. bbl/day) Production Few discoveriessince the 1980s Discoveries Source: HIS Energy, IEA, and Bernstein

  25. Russian Production Rising, but Reserves Falling (Bil. bbl) Cumulative Reserves Discovered Current Reserves Source: HIS Energy, IEA, and Bernstein

  26. Oil Production Growth Outside OPEC and FSU Very Disappointing (%) Source: BP Statistical Review, IEA, and Bernstein

  27. Growth in Oil Demand Accelerating due to Asia Million Barrels per Day +4.9 90.8 New AsianDemand +3.4 All OtherDemand 82.5 +3.3 +3.2 76.0 Source: BP Statistical Review, IEA, and Bernstein

  28. Demand for OPEC Oil to Rise Sharply Sources of New SupplyMillion Barrels per Day 8.3 6.5 OPEC All Other FSU 1999–2004 2004–2009E Source: BP Statistical Review, International Energy Agency, OPEC, and Bernstein

  29. China’s Entry into Global Business Cycle Has Broad Implications China GDP Growth Year-over-Year Percent Change Real GDP Growth Nominal GDP Growth Source: China National Bureau of Statistics and CEIC Data

  30. China Has Altered Global Pricing Patterns Cumulative Percent Change in Commodity and Goods Prices During Business Cycles Journal of Commerce Industrial Price Index* US Core Consumer Goods Prices *The Journal of Commerce industrial price index includes prices of textiles, metals, petroleum products and miscellaneous products such as hides and flooring. Source: Bureau of Labor Statistics, Economic Cycle Research Institute, Haver Analytics and Alliance Capital Fixed Income

  31. Low Import Inflation Has Kept Core Inflation & Interest Rates Low Import Price of Consumer Goods Excluding Autos Inflation and the 10-Year Treasury Yield 10-Year Treasury Yield Core CPI (YoY chg) Total CPI (YoY chg) Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve Board, Haver Analytics and Alliance Fixed Income

  32. Underlying Inflation: Labor Costs Contained Annual Rates 1990–1991 Recession First Two Years of Recovery Hourly Compensation 3.8% 4.4% Productivity (0.6) 3.0 Unit Labor Cost 4.4% 1.4% Source: US Department of Commerce and AllianceBernstein

  33. Underlying Inflation: Labor Costs Contained Annual Rates 1990–1991 Recession First Two Years of Recovery Hourly Compensation 3.8% 4.4% Productivity (0.6) 3.0 Unit Labor Cost 4.4% 1.4% 2001 Recession Hourly Compensation 3.2% 2.7% Productivity 4.0 4.8 Unit Labor Cost (0.8)% (2.1)% Source: US Department of Commerce and AllianceBernstein

  34. Labor Costs Still Contained 2001Recession First Two Years of Recovery Latest Year Hourly Compensation 3.2% 2.7% 4.2% Productivity 4.0 4.8 2.7 Unit Labor Cost (0.8) (2.1) 1.4

  35. How Attractive Is the Stock Market? About Average Equity Risk Premium* (%) Stocks Very Attractive +1 Std. Dev. Average -1 Std. Dev. Bonds Very Attractive Through March 31, 2005Treasury securities are guaranteed by the U.S. government as to the timely payment of principal and interest if held to maturity. *Difference between expected return on equities as represented by the S&P 500 and 10-Year U.S. Treasuries Source: Federal Reserve and Bernstein

  36. Economic Underpinnings Still Strong:Corporate Profit Margins at 30-Year High After-Tax Margins Recession (%) Average US nonfinancial corporationsSource: Bureau of Economic Analysis

  37. Operating Earnings $74 Adjustments Recurring “Nonrecurring” Charges (6) Stock-Option Expense (3) Lower Pension-Fund Returns (1) Available Earnings $64 Earnings Retained for 6% Growth 24 Available for Dividends $40 3.4%Yield Current Dividend $19 1.6%Yield Potential for Dividend Growth Unusually Large S&P 500One-Year Forward Estimate As of January 31, 2005Source: Bernstein estimates

  38. Conclusions • U.S. economy very sound • Construction spending should improve gradually • Dollar will weaken further • Oil prices will stay relatively high • Stock market reasonably valued

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