the great rebalancing...the great rebalancing david wyss chief economist standard & poor’s...
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Copyright (c) 2008 Standard & Poor’s, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.
The Great Rebalancing
David WyssChief EconomistStandard & Poor’s
July 24, 2008
2.
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The World Is Being Rebalanced
• World financial markets are undergoing an enormous relative shift
• Incomes in the developed world are rising slowly,
• While most of the emerging markets are growing rapidly.
• Wealth is piling up in the commodity producing countries,
• While high commodity prices are slowing growth in the U.S., Japan, and Western Europe.
• Financial problems, which started in the U.S. subprime mortgage market, have spread throughout the world.
• But the resulting imbalances are a threat to the stability of the world financial and trade system.
• The fight for control of natural resources could also lead to trade and other conflicts.
3.
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The Housing Bubble
• Housing was too affordable, thanks to low mortgage rates
• But what happened when rates went up?
• Ratio of home price to income hit a record high in 2006,
• Which could not be maintained at higher interest rates
• We built too many houses at too high prices
• Starts and sales have dropped sharply
• Defaults and foreclosures have soared, cutting back on willingness to lend
• Prices are down 15% from their peak
• We expect to hit bottom on starts this summer
• But prices probably won’t hit bottom until early 2009.
4.
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Home Prices Were Too High
2
2.5
3
3.5
4
4.5
1975 1979 1983 1987 1991 1995 1999 2003 2007 2011
Existing New Quality-adjusted
(Ratio of average home price to average household disposable income)
Source: BEA, Census
5.
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The Housing Market Cycle
0
500
1,000
1,500
2,000
2,500
1990 1993 1996 1999 2002 2005 2008-20
-10
0
10
20
30
Starts Home prices (%chya)
(Housing starts (1000) and 12-month % change in home prices (S&P/Case-Shiller))
Source: S&P and Census Bureau
6.
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Bubbles Were Almost Everywhere
-100 -50 0 50 100 150 200 250
Hong KongNewZealan
ChinaAustralia
JapanSpain
FranceSweden
ItalyIrelandBritain
NetherlandSwitzerland
GermanyCanada
US
(Percent increase in home prices, 1997-2005)
Source: Mortgage Bankers’ Association and S&P
7.
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Most Weakness Is In The Bubble Cities
Source: Standard & Poor’s, RealtyTrac
(S&P/Case-Shiller Home Price Indexes)
Apr-082002-2005
averageForeclosure rate
Top 5Charlotte -0.1 4.1 1.4Dallas -3.4 2.7 1.7Portland, OR -4.7 13.1 0.6Denver -4.7 2.6 2.6Seattle -4.9 12.2 0.5
National average -15.3 14.3 1
Bottom 5Las Vegas -26.8 17.5 4.2Miami -26.7 19.9 2.7Phoenix -25.0 20.6 1.9Los Angeles -23.1 15.8 1.4San Diego -22.4 17.2 1.8
(12-month percent change)
8.
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0
2
4
6
8
10
1995 1997 1999 2001 2003 2005 2007 2009 2011
Federal Funds Rate 10-Yr Bond Yield Muni bonds
(Percent)
The Fed Is Done Cutting
Source: Federal Reserve, Bond Buyer
9.
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Foreign Money Is Coming Into Private Bonds
0200000400000600000800000
100000012000001400000
2001 2002 2003 2004 2005 2006 2007
Treasury Agency Private Equity
Source: US Treasury.
(Net inflows of long-term capital, Millions of dollars)
10.
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Global M&A Activity
Announced M&A Deal Volume $bn
-
1,000
2,000
3,000
4,000
5,000
6,000
7,000
2002 2003 2004 2005 2006 2007 2008E
March YTD FullYear
11.
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Financial Markets Are Rising Rapidly
0 100 200 300 400 500
USEurozone
JapanRussia
E. EuropeLatin America
ChinaIndia
Emerging Asia
Equity Private debt Public debt Bank deposits
(Assets as percent of GDP, 2006)
Source: McKinsey Global
12.
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Enterprise Risk Management: What will S&P be looking for?
• Management deliberately intends to actively manage key their risks.
• Management has allocated sufficient resources for risk management to reasonably expect achievement of objectives.
• Decision making reflects impact of decisions on risks of the organization.
• Managers understand the firm’s risk tolerance for the risks that are within their remit.
• Board is involved in making and/or approving risk tolerances and major policies regarding risk and supports management’s risk management intentions.
• Long term planning and resource allocations reflect risk reward as well as cost benefit of alternatives.
• Stakeholders have confidence in management’s ability to manage the risks of the firm.
13.
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The World Is Ignoring The U.S. Sniffles
• World growth remains solid
• Slower growth in the US and Europe is offset by stronger growth in Asia
• The train has more engines attached
• And the world is thus less dependent on US growth
• We expect a slight slowdown in world growth, to 3.9% from 4.9% in 2007
• But the big trade and capital imbalances are a risk
• And higher oil prices could still slow growth more
14.
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World Growth Remains Strong
0
2
4
6
8
10
UnitedStates
WesternEurope
Japan EasternEurope
OtherAsia-Pac
LatinAmerica
Mid East& N
Africa
Sub-SaharanAfrica
2006 2007 2008 2009 2010
(Real GDP, % change)
Source: Global Insight and S&P
15.
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And Comes Mostly From Asia
US20%
Eurozone15%
Japan6%
Other Adv11%
China15%
India6%
East Eur7%
Other 20%
(IMF purchasing power weights, 2006)
US12%
Eurozone9%
Japan3%
Other Adv7%
China30%
India11%
East Eur11%
Other 17%
Percent of World GDP Percent of World Growth
Source: IMF
16.
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A Longer-Term View Shows The Swing
US23%
Eurozone21%
Japan8%
UK4%China
3%
India4%
Brazil3%
Other 34%
(IMF purchasing power weights, Percent of world GDP)
US20%
Eurozone16%
Japan7%UK
3%China14%
India6%
Brazil3%
Other 31%
1971-1975 2001-2005
Source: IMF
17.
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Different Economic Performances
0
2
4
6
8
10
12
U.S.
Canad
a
Australia
Japan
France
Germany
Italy
U.K.
2005 Jun-05
(Unemployment rate, %)
Source: BLS
18.
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European Productivity Growth Trails
Source: BLS
19.
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World Imbalances Are Becoming Dangerous
• The US has been absorbing most of the world trade surplus
• Slower US growth has slowed imports
• A weaker dollar has helped exports
• But rising oil prices are keeping the deficit large
• The US trade deficit cannot be sustained at its current level
• But with large surpluses in the OPEC countries and other commodity producers
• It is hard to see how the US can get closer to balance
• Without Europe running a large deficit
• Or China and Japan moving into balance
20.
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US Trade Deficit Balances Surpluses Elsewhere
-8
-6
-4
-2
0
2
4
6
8
10
US Canada Germany France Italy UK Japan Korea China India
(Trade balance percent of GDP, 2007)
Source: Global Insight
21.
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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
22.
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-200-100
0100200300400
1990 1993 1996 1999 2002 2005
(Capital balance, $billion, 34 emerging economies)
Emerging Markets Have Become Capital Exporters
Source: McKinsey Global
23.
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0
10
20
30
40
50
60
Canada
France
Germany
Italy
Japan
KoreaMexic
o UK US
25-34 45-54
(Percentage of tertiary degrees by age group, 2003)
Other Countries Are Catching Up On Education
Source: OECD
24.
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Changing Industry Mix
Source: BLS
25.
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Fiscal Deficits Almost Everywhere
-8
-6
-4
-2
0
2
4
US Canada France Germ. Italy UK Japan
2004 2007
(Government balance as percent of GDP)
Source: IMF
26.
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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 Germany2005 2025 2050
(Government debt as % of GDP)
Source: S&P
27.
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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
28.
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The Stock Market Is Heading Down
• Double-digit earning gains for a record 18 quarters• But earnings are now down for three consecutive quarters
(entirely because of financials).• Profits were at a record high relative to GDP• Earnings are slowing to below GDP growth• Share prices cannot continue to outpace earnings• Especially when interest rates rise• Stocks were overdue for a correction• But this was not quite a bear market• And we think the market will improve, but slowly.
29.
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Most Markets Are At New Highs
-100 -50 0 50 100 150 200 250 300 350 400
World (1200)
US (500)
Canada (60)
Lat Am (40)
Europe (350)
Japan (150)
Asia/Pacific (50)
Australia (50)
Oct-02 May-08
(Change in S&P stock indexes since March 2000 peak)
Source: S&P
30.
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Most US Sectors Have Recovered From The Bear Market
-100 0 100 200 300
S&P 500Cons Discr
Cons StaplesEnergy
FinancialsHealth CareIndustrials
TechnologyMaterials
TelecommUtilities
Oct-02 May-08
(Change in S&P 500 sectors since March 24, 2000 peak)
Source: S&P
31.
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High Global Equity Correlation
Source: Standard & Poor’s Equity Research, MSCI (through July 31, 2007)
S&P 500 S&P MC 400 S&P SC 600 MSCI EAFE MSCI EMS&P 500 1.00 0.88 0.79 0.84 0.70S&P MC 400 0.88 1.00 0.96 0.75 0.67S&P SC 600 0.79 0.96 1.00 0.71 0.63MSCI EAFE 0.84 0.75 0.71 1.00 0.83MSCI EM 0.70 0.67 0.63 0.83 1.00
60-Month Correlations
32.
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0
10
20
30
40
50
60
1997 2006US Canada Eurozone UK Japan Other DevChina Russia Brazil India Other
Source: Goldman Sachs
(Stock market capitalization, $trillion)
World Stock Markets Are Rising
33.
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Emerging Markets Are Growing Faster
0%
20%
40%
60%
80%
100%
2006 2026US Canada Eurozone UK Other EurJapan Other Asia S Amer Mid East Africa
Source: Goldman Sachs
(Stock market capitalization, % of world total)
34.
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