David Wyss, Brown University/Standard & Poor - Speaker at the 2012 IFG Wealth Management Forum, delivered his presentation entitled The Economy and Financial Markets: Crawling Out of Recession

1. THE ECONOMIC OUTLOOK:
HALF-SPEED AHEAD
David Wyss
Brown University
April 24, 2012

2. The Pace Of The Recovery Has Slowed
• A recovery is underway, but is likely to remain weak.
• Housing now appears to be stabilizing, although prices are still falling.
• Overseas partners are recovering, helping exports. The financial
problems add to risks and probably mean a recession in Europe.
• The fiscal stimulus helped boost the economy, but is being reversed.
The Washington gridlock makes any help from Washington unlikely, and
the government could cause a recession.
• Private nonresidential construction remains weak, but equipment
spending has begun to recover
• Consumers aren’t bouncing back as quickly as usual, but are showing a
few more signs of life as they start replacement purchases.
• Another dip into recession is possible if the financial markets lock up
again or oil prices jump farther on Middle East turmoil.
2.

3. The Housing Bubble
• Housing was too affordable, thanks to low mortgage rates
• Ratio of home price to income hit a record high in 2007.
• We built too many houses at too high prices
• Starts and sales dropped sharply
• Defaults have soared, cutting back on willingness to lend
• Prices fell one-third from their peak, with the price/income ratio below
its historical average
• Starts and sales are recovering
• But prices are likely to drop back through spring.
3.

4. Home Prices Were Too High
(Ratio of average home price to average household disposable income)
4.5
4
3.5
3
2.5
2
1975 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015
Existing New Quality-adjusted
Source: Bureau of Economic Analysis and Census Bureau
4.

5. Bubbles Were Almost Everywhere
(Percent increase in home prices, 1997-2005)
US
Canada
Germany
Switzerland
Netherlands
Britain
Ireland
Italy
Sweden
France
Spain
Japan
Australia
China
NewZealand
Hong Kong
-100 -50 0 50 100 150 200 250
Source: Mortgage Bankers’ Association and Standard & Poor’s
5.

6. Those Who Bubbled Highest Burst Loudest
(Percent increase in S&P/Case-Shiller home price index, July 2011)
Miami
Los Angeles
Washington
San Diego
Tampa
Las Vegas
Phoenix
San Francisco
New York
Seattle
Portland
Boston
Minneapolis
Chicago
Denver
Charlotte
Atlanta
Detroit
Dallas
Cleveland
-100 -50 0 50 100 150 200
peak-present 2000-peak
Source: Standard & Poor’s
6.

7. The Fed Didn’t Stop At Nothing
(Percent)
10
8
6
4
2
0
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Federal Funds Rate 10-Yr Bond Yield Mortgage rate
Source: Federal Reserve
7.

8. Synchronized Sinking
• Industrial countries went into recession in 2008, and into a plunge in the
fourth quarter of 2008
• Real GDP fell in the U.S., Japan, and Europe
• Developing countries looked like they might escape
• Until commodity prices plunged in Q4 2008
• World GDP is recovering, up 4.2% in 2010 from -2.1% in 2009
• The most synchronized world recession in history is being followed by a
slow, less synchronized recovery
• Problems in Europe and Japan will further cut developed country
growth, with Japan back in recession.
• But Asia continues to grow strongly
8.

9. Synchronized Sinking
(Real GDP, % change)
10
8
6
4
2
0
-2
-4
-6
-8
2007 2008 2009 2010 2011 2012 2013
Source: Global Insight and Standard & Poor’s
9.

10. Trade Gap And Reserve Diversification Will Send Dollar Lower
(Index) (Percent of GDP)
1.4 0%
1.3 -1%
1.2 -2%
1.1 -3%
1 -4%
0.9 -5%
0.8 -6%
0.7 -7%
2000 2002 2004 2006 2008 2010 2012 2014
Net exports (right) Dollar index (major trading partners)
Source: Bureau of Economic Analysis and Federal Reserve, S&P projections
10.

11. Timeo Danaos Et Debitum Ferentes
(Central government debt as percent of GDP, 2010)
Source: Standard & Poor’s from national sources
11.

12. Budget Deficits Depend On Economy
(Budget gap as percent of GDP, 2010)
0 2 4 6 8 10 12
Australia
Canada
China
France
Germany
Greece
India
Italy
Japan
Korea
Spain
UK
US
Source: Standard & Poor’s CRISIL
12.

13. Deficits Are Mostly Cyclical
(Government deficit as % of GDP, fiscal years)
4
2
0
-2
-4
-6
-8
-10
-12
2000 2003 2006 2009 2012
stimulus ex stimulus
Source: Standard & Poor’s
13.

14. The Future Looks Bleak
(Government debt as % of GDP)
800 753
700
600
500
415 431
404 400
400
308
300
180 192 184
200 155
106
100 69 72 79 75
0
US Japan UK France Germany
2010 2030 2050
Source: Standard & Poor’s, 2010
14.

15. Aging Populations Will Boost Government Spending
(Retirees as percentage of labor force)
80
70
60
50
40
30
20
10
0
US Canada France Germany Italy UK Japan Australia China OECD
2010 2030
Source: Organization for Economic Cooperation and Development
15.

16. Weaker Employment Is Hurting Construction
(4-quarter percent change)
20% 4%
3%
10%
2%
1%
0%
0%
-10% -1%
-2%
-20%
-3%
-4%
-30%
-5%
-40% -6%
2005 2007 2009 2011 2013 2015
Nonresidential construction Nonfarm employment
Source: Bureau of Labor Statistics, Bureau of Economic Analysis, S&P projections
16.

17. Commercial Real Estate Price Declines Are Bottoming
240
220
200
180
160
140
120
100
80
60
Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08
Source: M.I.T. Center for Real Estate.
17.

18. Equipment Spending Follows Capacity Needs
(4-quarter percent change, and production as % of capacity) (Percent)
20% 85
10% 80
0% 75
-10% 70
-20% 65
-30% 60
2000 2002 2004 2006 2008 2010 2012 2014
Business equipment (real, left scale) Capacity Utilization, mfg (Right)
Source: Federal Reserve, Bureau of Economic Analysis
18.

19. Can the Consumer Keep Spending?
• Consumer spending led recent expansions
• But wealth is down because home prices have dropped and
• Stocks are still below their 2007 peak
• Borrowing is more difficult, and home equity loans much
less available
• Confidence has dropped and unemployment risen
• Consumers are likely to continue to save more and
borrow less
• High oil prices hurt purchasing power and confidence
• Stimulus package provided some income boost
19.

20. Debt Is Dropping From Record Highs
(Percent of after-tax income)
7 1.5
6 1.4
1.3
5
1.2
4
1.1
3
1.0
2
0.9
1 0.8
0 0.7
2000 2002 2004 2006 2008 2010 2012 2014
Saving rate Debt/income (right scale)
Source: Bureau of Economic Analysis and Federal Reserve
20.

21. Wealth Slides With Home and Stock Prices
(Percent of after-tax income)
700%
600%
500%
400%
300%
200%
100%
0%
1990 1993 1996 1999 2002 2005 2008 2011 2014
Net worth Financial assets
Source: Federal Reserve
21.

22. Default Rates Begin To Drop
(Percent)
9
8
7
6
5
4
3
2
1
0
2005 2005 2006 2007 2007 2008 2009 2009 2010 2011
Auto BankCard First Mtg Second Mtg
Auto BankCard First Mtg Second Mtg
Source: S&P/Experian
22.

23. Bigger Than The Average Bear
• A great run from 1982 to 2000
• But the secular bear began in 2000
• Two largest bear markets since the depression
• Earnings were negative in 2008 Q4 for first time in history
• We think the rally will continue
• But the long-term cycle probably has another bear in it.
• World stock markets have generally become synchronized
• As money flows between markets in search of yield
23.

24. Bottom Line: The Economy Will Recover Slowly
• The recession is the longest and deepest since the 1930s
• Fiscal stimulus has supported the recovery
• But recovery is likely to be slow because of financial markets and
switch to higher savings
• If financial markets lock up again
• Fiscal stimulus ends abruptly
• Home prices continue to fall
• And oil prices continue to rise
• The recession could be longer and deeper
• With the risk of a “lost decade” similar to Japan in the 1990s
24.

25. Oil Prices Remain Down From Peak
($/barrel, WTI and deflated by CPI; household energy purchases as percent of
disposable income)
140 9%
120 8%
100
7%
80
6%
60
5%
40
20 4%
0 3%
1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Oil Price (WTI) 2005 Dollars % of disp. income
Source: Bureau of Economic Analysis
25.