Financial Sector Analysis

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Financial Sector Analysis

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Recommendation

• Current weight of financial sector in SP 500
• 19.10
• Current portfolio weight of financial sector
• 15.57
• Recommendation Overweight the financial sector
• Increase portfolio weight to 20

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Portfolio Update

• Winter Quarter 2002
• Financial sector portfolio weight was 12.81
• WI 02 Recommendation increase financial sector
  portfolio weight to 17.81
• WI 02 Outcome increased portfolio weight to
  15.88
• Expected economic recovery
• Low interest rates

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Economic Outlook and Valuation
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Interest Rates

• Short Term
• Low
• Federal Reserve may leave rates at 40 yr low
• Beige book
• Economic stagnation
• Low/falling rates increase demand for credit

• Low interest rates and economic rebound in 2002
  should support growth and profits in the sector
• Good for financial sector

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Fed Policy

• Quasi-restrictive
• Loose Monetary Policy
• Pumped a lot of money into the economy
• Fed Funds rate
• Low 1.75
• Yield Curve
• Steep
• Beginning of economic expansion

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GDP

• Expanded at 5.8 in the first quarter 2002
• Corporate profits
• Fits and starts
• High recent correlation of GDP and corporate
  profits
• Slow recovery
• Challenges from weak economy and lower consumer
  confidence
• Overall mixed signs of recovery in GDP

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Sector Trends

• Consolidation
• International Branding
• Globalization
• Co-Branding
• Consumer Bankruptcy

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SP FINANCIAL SECTOR
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Sub Sector Descriptions
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Diversified Financial/Banks

• Three Most Influential Factors
• Gross Domestic Product
• Interest Rates
• Federal Reserve Monetary Policy

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Diversified Financial/Banks

• Gross Domestic Product
• Increased 5.8 1st qtr. 2002
• Expectations
• Federal Reserve expects a 4 4 1/2 nominal
  growth
• Expects a 2 1/2 3 real growth

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Diversified Financial/Banks

• Interest Rates
• Steep Yield Curve
• Long-term bond holders expect economic
  improvement
• Typical at beginning of expansion, end of
  recession
• Long-term investors demand greater compensation
• Fear being locked into low rates
• Very good for cyclical sub-sectors such as
  Diversified Financial and Banks

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Diversified Financial/Banks

• Monetary Policy
• Aggressively loosened stance in 2001
• Provided support for spending and housing
• Future Outlook
• Hold rates even until June
• Believe expansion will increase gradually
• Unemployment still expected to rise before it
  falls
• Demand for loans increasing

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Insurance Industry

• Current State-
• Defensive
• Stable demand
• Stable underwriting profits
• Industry is strong- has excess capital
• 9/11 disaster will be absorbed
• New products and increased demand are fueling
  growth

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Insurance Industry

• Major Economic Factors-
• Interest Rates
• Low interest rates hurt investment results in
  short-term
• Increase value of long-term holdings
• Capital Market Volatility
• Hurts realized and unrealized gains
• Demographics
• Increasing demand for savings-type life insurance
  products
• 30 of population are baby-boomers

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Insurance Industry

• Pretax profits down 40 for P/C in 2000
• Weak premium pricing
• Impaired investment results
• Premium prices have increased due to greater
  demand in products
• Written premium growth of 5.1 last year
  (ten-year high)

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Financial Sector Summary

• Personal Savings Rate
• Low interest rates
• Consolidation
• Economic Recovery

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Sector EarningsOperating Earnings Per Share
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Sector EarningsAverage Annual Growth-3 years

• SP 500
• 1999 15
• 2000 8.6
• 2001 (0.2)
• Growth Rate
• 7.8

• Financials
• 1999 18.5
• 2000 7.0
• 2001 5.6
• Growth Rate
• 10.37

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Conclusion

• Financial Sector is poised to realize excess
  returns in immediate future
• Recommendation Increase weight of the financial
  sector to 20