CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s.

CONFIDENTIAL AND PROPRIETARY.

Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s.

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.



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.



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.



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.



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.



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.



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.



Quality Spreads Grind Tighter

0100200300400500600700800900

2003 2004 2005 2006

Investment grade Speculative grade

(Spread over Treasury yields, basis points)

Source: S&P

9.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



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.



Analytic services and products provided by Standard & Poor’s are the result of separate activities designed to preserve the independence and objectivity of each analytic process. Standard & Poor’s has established policies and procedures to maintain the confidentiality of non-public information received during each analytic process.

CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s.

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