The Economy and Financial Markets November 15, 2007

The Economy and Financial Markets

November 15, 2007

Economy and Financial Markets:Current Conditions

• Economy still strong in Q3, real GDP up 3.9%.

• Inflation contained – core falling to, or below, 2%.

• Profits / Earnings one time hit likely in Q3 – sub prime related.

• Stock price gains expected to match earnings growth.

• Risks are the same – terrorism, Iraq, oil prices.

• Bond market risk moderate due to good inflation outlook.

• Credit market concerns appear overblown, damage limited.

• $ exchange rate bouncing off a new record low.

Quarterly % Change in Real GDP % Change - Annual Rate

12-Month % Change in Payroll Employment % Change - Year to Year

05009590Sources: BEA, BLS /Haver 11/15/07

8

6

4

2

0

-2

-4

8

6

4

2

0

-2

-4

GDP Growth: Q3 GDP Up 3.9%, Employment Growth +1.2%

ECRI Weekly Leading Index1992=100

Dow Jones U.S. Business Barometer Index2000=100

05009590Sources: ECRI, BTMU /Haver 11/15/07

160

140

120

100

80

104

100

96

92

88

84

ECRI & Dow Barometer Both Down, Expect Slowdown, Not Recession

ICSC-UBS Weekly Retail Chain Store SalesSA, 1977=100

Real Disposable Personal IncomeSAAR, Bil.Chn.2000$

05009590Sources: ICSCUBSW, BEA /Haver 11/15/07

500

450

400

350

300

250

200

9000

8000

7000

6000

5000

Real Personal Income Rising, Chain Store Sales Soften.

Shipments of Manufacturing Durable GoodsSA, Mil.$

New Orders for Manufacturing Durable GoodsSA, Mil.$

05009590Source: Census Bureau /Haver Analytics 11/15/07

250000

225000

200000

175000

150000

125000

100000

250000

225000

200000

175000

150000

125000

100000

New Orders & Shipments Flatten – Business Spending Okay

Unfilled Orders for Durable Goods: Order Backlog Very HighSA, Mil.$

Ratio of Inventories to Shipments: Low - No Inventory BacklogNMIDG / NMSDG

050095908580Source: Haver Analytics 11/15/07

800000

700000

600000

500000

400000

2.75

2.50

2.25

2.00

1.75

1.50

1.25

Order Backlog Very High, Inventories Low Relative to Shipments

Median Sales Price: Existing 1-Family Homes$

Ratio: Median Price / Disposable Income per CapitaMeasure of housing P/E


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, Housing “P / E” Now Way Down

Housing StartsSAAR, Thous.Units

New Single Family Home SalesSAAR, Thous


2400

2000

1600

1200

800

400

1400

1200

1000

800

600

400

However, New Home Sales and Starts Continue to Plunge

Loan Delinquency Rate: All Commercial BanksSA,%

Loan Charge-Off Rate: All Commercial BanksSA,%

0500959085Source: Federal Reserve Board /Haver Analytics 11/15/07

7

6

5

4

3

2

1

0

7

6

5

4

3

2

1

0

Major Credit Threat? No – Total Bank Problem Loans Remain Low Residential Loan Delinquency 2.3%, Defaults 0.2%, Likely To Rise

US Export Growth12-Month Percent Change

US Import Growth12-Month Percent Change


30

20

10

0

-10

-20

30

20

10

0

-10

-20

US Trade Upturn Offsets Housing Weakness. Exports Now Rising Four Times as Fast as Imports (13% vs. 3%)

Weekly Initial Claims for Unemployment InsuranceSA, Thous

Unemployment RateSA, %

05009590Sources: DOL, BLS /Haver 11/15/07

600

525

450

375

300

225

8.25

7.50

6.75

6.00

5.25

4.50

3.75

Claims Lead Unemployment Rate – Steady Indicating Okay Labor Mkt.

Change in Total Employment Cost Index (Wages + Benefits)Private Sector: 4-Quarter % Change

Change in Benefits Cost - Has Slowed Considerably4-Quarter % Change

05009590Source: Bureau of Labor Statistics /Haver Analytics 11/15/07

8

7

6

5

4

3

2

1

8

7

6

5

4

3

2

1

Employment Cost Inflation at 3% - Benefit Costs Under Control

Total CPI Inflation % Change - Year to Year

Core CPI Inflation (Excludes Food & Energy % Change - Year to Year

05009590Source: Bureau of Labor Statistics /Haver Analytics 11/15/07

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 2.2%

Fed Funds Target RateEOP, %

Sum of Core CPI Inflation and Payroll Employment Growth%


10

8

6

4

2

0

10

8

6

4

2

0

Fed Target Is (Roughly) Core Inflation + Employment Growth. We Think The Recent Cut to 4.5% Was The Right Policy Action.

4.5% fed funds rate still well above 3.4% sum of core CPI inflation of 2.2% and job growth of 1.2%.

Fed over did it in late 1999 - 2000

Crude Oil Price - West TexasEOP, $/Barrel

Dollar Exchange Rate - Major Currency IndexAvg, 3/73=100

05009590Sources: WSJ, FRB /Haver 11/15/07

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? Nope.

Record oil price behind us? Nope.

S&P 500: After-tax Earnings with Next Quarter Estimate$/Shr

S&P 500: Operating Earnings with Next Qtr Estimate$/Share

05009590Source: Standard & Poor's /Haver Analytics 11/15/07

24

20

16

12

8

4

0

28

24

20

16

12

8

4

Company Earnings Outside Financials Strong, But Big Q3 Hit From Sub Primes. “Concensus Forecast” Expects Q3 Hit Then Q4 Rebound

P/E Ratio: S&P 500 Stock Price Divided By Same Quarters EarningsP/E calculated using current quarter operating earnings times 4


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 17 – Looks Reasonable Higher Risk on the Value Side, Lower Risk on the Growth Side

Higher Risk Region

Lower Risk Region

US Net New Equity Issues: Record High Stock Buybacks!New Equity Issued less Stock Bought Back in $Billions at Annual Rates


200

0

-200

-400

-600

-800

200

0

-200

-400

-600

-800

Record U.S. Net Stock Repurchases - $590 Billion Last Four Quarters

Financial Assets Less Liabilities of All US Nonfinancial Corps.billions - US companies are now net lenders


1500

1000

500

0

-500

-1000

-1500

1500

1000

500

0

-500

-1000

-1500

Corp. Balance Sheet – Companies’ Financial Assets Exceed Liabilities by $1.3 Trillion. Now Net Lenders, Usually Are Net Borrowers

Total US non-financial companies net lenders

Total US non-financial companies net borrowers

Equity Total Return Beats Fixed Income, But With Volatility

S&P 500 Total ReturnEOMLehman Bond Index: US Aggregate Total ReturnEOP, Dec-31-75=100 05009590Sources: Standard & Poor's, Lehman Brothers/ Haver Analytics 11/15/0725002000150010005000 25002000150010005000

Total Return: Russell 3000 Value Index5/31/95=1000

Total Return: Russell 3000 Growth Index5/31/95=1000

0807060504030201009998979695Source: Frank Russell Company /Haver Analytics 11/15/07

4500

3750

3000

2250

1500

750

4500

3750

3000

2250

1500

750

Value Has Outperformed Growth Since 2000 – Is Now Reversing

Cumulative Total Return of Value Relative to GrowthRatio: Russell 3000 Value / Growth Total Return Indices


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

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 11/15/07

4500

3750

3000

2250

1500

750

4500

3750

3000

2250

1500

750

Small Caps Outperformed Large Caps Since 1999 – Now Reversing

Cumulative Total Return of Small Relative to Large CapsRatio: Russell 2000 / Russell 1000 Total Return Indices


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

30-Year Treasury Bond YieldAvg,%

2-Year Treasury Note YieldAvg, %

05009590Sources: Haver Analytics, U.S. Treasury 11/15/07

10

8

6

4

2

0

10

8

6

4

2

0

Long Rates Stable, Short Rates Down, Another Fed Rate Cut? Maybe.

High Yield RateSource: Merrill Lynch

Yield Spread: High Yield Rate Less 5-Year Treasury Rate%


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

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


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 Mkt.

Conclusions• GDP growth for 07 would be 4% if oil was in $35 range.

• $80+ oil knocks 1%+ off GDP & cut jobs gain by 800,000.

• Total inflation up on oil prices, but core inflation remains low.

• Earnings are generally okay – expect about 10% 2007 Q4/Q4.

• S&P 500 P/E at 17 – low enough for prices to track earnings.

• Earnings and Balance Sheet quality look high.

• Bond risk moderate, subprime problems not likely to spread.

• Dollar exchange rate risk now low (down at new record low).

• Fed funds rate cut to 4.5% on Oct. 1. Uncertain on future cuts.

Required Disclosures:

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 Economy and Financial Markets November 15, 2007

Documents

year cpi

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loan delinquency rate

year core cpi inflation

year gdp

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total cpi inflation

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