The Economic Outlook: Oil and Deficits

1
The Economic Outlook Oil and Deficits
David Wyss Chief Economist 212-438-4952 David_Wyss
_at_standardandpoors.com September, 2005
2
The Recovery Is Slowing

• After a strong 2004
• Growth is slowing towards trend
• Consumers are spending all their income
• Interest rates are rising
• Which will slow housing and consumer spending
• Tax cuts are over, and the saving rate is zero
• But capital spending is accelerating
• Federal deficits are coming down
• So growth remains solid
• Higher oil prices could stall the expansion
• And world economic stagnation continues to widen
  the trade gap

3
Oil Prices Are Hitting New Highs
(/barrel, WTI and deflated by CPI household
energy purchases as percent of disposable income)
4
How Long Do We Work to Drive 100 Miles in the
Average Car?
(Minutes)
5
The Fed Is Moving Toward Neutral
(Percent)
6
The Trade Gap Yawns Wider
(Percent of GDP)
7
World Growth Is Slowing
(Real GDP, change)
8
And Comes Mostly From Asia
(IMF purchasing power weights, 2004)
Percent of World Growth
Percent of World GDP
9
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 low
• Tax cuts are over
• Interest rates are rising
• And gasoline is at a record high
• Net result will be a slowdown, not a retreat
• The saving rate will remain low

10
Debt Service Now Above 1986 Record
(Household obligations as percent of after-tax
income)
11
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
• And the ratio of home price to income is at a
  record
• 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

12
Home Prices Are High Relative to Household Income
(Ratio of average home price to average household
disposable income)
13
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-tying 13
  quarters
• 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 a near-term rally is being spurred by strong
  earnings and dividend tax cuts

14
Most US Sectors Have Recovered from the Bear
Market
(Change in SP 500 sectors since March 24, 2000
peak)
15
Bottom Line The Economy Recovers, But Slowly

• Consumers are spending near max
• Businesses are taking over the lead
• But fiscal policy stimulus is over
• Interest rates rise gradually
• 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

16
Risks to the Economy
(Real GDP, percent change year ago)
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