# Presentation: 671409

## The Economic and Financial Outlook: An Energetic Economy

**David Wyss**
**Chief Economist**
**212-438-4952**
- _[David_Wyss@standardandpoors.com](mailto:David_Wyss@standardandpoors.com)_
- EIA Energy Modeling Conference
- Washington
- April 12, 2005

## The Recovery Is Finally Accelerating

- After two years of sluggish expansion
- Jobs are finally materializing
- Up to now, the recovery has run on two legs – consumer and government spending
- Now equipment spending is rising
- And nonresidential construction is starting to recover
- Higher interest rates will slow housing and consumer spending
- Tax cuts are over, and the saving rate is already low
- Federal deficits will come down slowly
- But higher oil prices could stall the expansion
- And world economic stagnation continues to widen the trade gap

## Oil Prices Are Hitting New Highs

- ($/barrel, WTI and deflated by CPI;
- household energy purchases as percent of disposable income)

## Energy Consumption 

## World Energy Consumption

- 1973

- 2002

## Energy Consumption by Region

- 1973

- 2002

## US Was Nearly Self-Sufficient Until 1970

## How Long Do We Work to Drive 100 Miles in the Average Car?

- (Minutes)

## Components of Electricity Fuel Use

- (Percent of total use)

## Inflation Remains Mild

- (Percent change in CPI)

## Unemployment Rates Are High

- (Percentage of labor force, 2003)

## The Fed Is Moving Toward Neutral

- (Percent)

## Quality Spreads Grind Tighter

- (Spread over Treasury yields, basis points)

## Emphasis in second term will shift to controlling deficit
The current deficit is manageable (3% of GDP)
But few prospects for controlling it
Creating an “Ownership Society”
Social security reform is getting most attention
We have promised more than we have money to pay
Benefit cuts or tax increases
Partial privatization will be main Administration proposal
Tax reform rather than tax cuts
Changes should be revenue neutral
More consumption-based taxation
Encourage saving
Cut deficit in half by fiscal 2008
Requires tough control of government spending
Could be derailed by international events

- The current deficit is manageable (3% of GDP)
- But few prospects for controlling it
- Creating an “Ownership Society”
- Social security reform is getting most attention
- We have promised more than we have money to pay
- Benefit cuts or tax increases
- Partial privatization will be main Administration proposal
- Tax reform rather than tax cuts
- Changes should be revenue neutral
- More consumption-based taxation
- Encourage saving
- Cut deficit in half by fiscal 2008
- Requires tough control of government spending
- Could be derailed by international events

- Second-Term Policies

## The Future Looks Bleak

- (Government debt as % of GDP)

## Where the Money Goes

- (Federal spending, percent of GDP, CBO estimates)

## The Trade Gap Yawns Wider

- (Percent of GDP)

## Taking the Dollar Down

- (Real trade-weighted dollar)

## World Growth Is Slowing

- (Real GDP, % change)

## US Deficit Balances Other Surpluses

- (Trade balance as percent of GDP, 2004)

## US Borrows From Abroad to Offset Weak Savings

- (Percent of GDP)

## European Investment Lags US and UK

## European Productivity Growth Trails

- (Output per hour, percent change)

## Other Countries Are Catching Up

- (Percentage of college graduates by age group)

## Capital Spending Follows GDP

- (4-quarter percent change)

## Weak Employment Means Weak Construction

- (4-quarter percent change)

## Can the Consumer Keep Spending?

- Spending has led the expansion
- The tax cuts provided extra income
- Lower mortgage rates freed up funds
- Confidence is improving
- But the saving rate is low
- Tax cuts are over
- Interest rates are rising
- And gasoline at a record high
- Net result will be a slowdown, not a retreat
- But the saving rate will remain low

## Car Sales Remain Strong Despite Gasoline Prices

## Trucks Dominate New Vehicle Sales

- (Cars as percentage of total vehicles)

## Debt Service Now Above 1986 Record

- (Household obligations as percent of after-tax income)

## Household Debt  By Country

- (Percent of income, 2001)

## Household Net Worth  By Country

- (Percent of income, 2001)

## US is Actually Low-Debt

- (Assets as percent of GDP, 2002, source: IMF)

## A Housing Bubble?

- Housing is the most affordable it has been since the early 1970s
- Thanks to low mortgage rates
- Home prices have outpaced incomes
- But ratio of home price to income is only moderately high
- There are local bubbles
- E.g., New York, Bay area, Boston, DC
- And higher mortgage rates will cause weakness
- But housing looks less overvalued than other assets

## More Affordable Housing Allows More Households To Own Their Home

## Home Prices Are High Relative to Household Income

- (Ratio of average home price to average household disposable income)

## The Stock Market Will Recover, But Slowly

- Market rose over 20%/year from 1995 -99
- But dropped from March 2000 through June 2003
- First three consecutive down years since 1939-41
- Biggest drop since 1929-32
- Profits cannot continue to outpace GDP
- 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 a near-term rally is being spurred by earnings recovery and dividend tax change

## Stocks Aren’t Overvalued Any More

- (10-year Treasury yield vs price/earnings ratio, S&P 500 operating earnings)

## Most Sectors Have Recovered from the Bear Market

- (Change in S&P 500 sectors since March 24, 2000 peak)

## Long Bull Markets Are Followed by Periods of Weakness

- (Percent return on S&P 500 and corrected by CPI)

## High P/Es are Concentrated in Tech

- (Based on 12-month forward operating earnings, Today vs. March 2000)

## Highest Leverage in Utilities and Consumer Discretionary

- (Debt as percent of market value in third quarter 2004)

- Source: Compustat

## Bottom Line: The Economy Recovers, But Slowly

- Consumers are spending near max
- Businesses will not take over the lead yet
- But strong stimulus from fiscal policy
- Interest rates rise gradually next year
- Housing prices and starts slow
- Weak recovery for stock market
- Risk of recession remains if:
- Further terror attacks damage confidence
- War disrupts oil supplies
- World deflation sucks the US  into slower growth

## Risks to the Economy

- (Real GDP, percent change year ago)

## Economic Updates

- Thank you for your attention
- If you would like to receive our regular economic and credit market updates, please register at:
- http://info.standardandpoors.com/mk/get/ECMR_REG_FORM