Transcript Document

Outlook & Opportunities
Terry Sandven
Christian Heitzman
July 2007
Since 1895. Member SIPC and NYSE.
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Mid-Year Review & Outlook
Overview
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Performance
Interest rates
Inflation
Housing
Earnings
Mid-Year Review & Outlook
Recap of First Quarter Outlook
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First quarter Outlook
– Pro-growth thesis remains intact.
• Inflation will remain contained.
• Economic expansion will continue, albeit at a slower rate.
• Fed is not likely to move until second half of 2007; should subprime deterioration continue, next move is likely to cut; Fed is not
under any immediate pressure to change its stance.
• Bonds and stocks will likely trend within a relatively narrow trading
range, with an upward bias.
• Biased toward a pro-growth economy, driven largely by favorable
employment conditions.
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Mid-Year Outlook
– Largely the same as the first quarter.
• Evidence of some global inflation.
• Fed may not move in 2007.
• Equities are likely to outperform bonds in the second half of 2007.
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Performance
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Performance
Seasonality
AVERAGE S&P 500 MONTHLY PERFORMANCE
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%
-2.0%
JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC
Jan. 1950 to April 2007
Jan. 1975 to April 2007
Data Source: Ibbotson Associates and FactSet Research Systems, Inc.
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Jan. 1995 to April 2007
Interest Rates
Secular Change?
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The 10-year Treasury topped 5.0% for the first time
since July 2006 before peaking at 5.31%.
Interest Rates
U.S. Treasury Yield Curve
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Yield curve has flattened.
1 Year Ago
3 Mo n th s A go
1 W e ek A g o
0 9-J ul -07
5 .2
5 .1
5 .0
4 .9
4 .8
4 .7
3 Mo
6 Mo
Source: FactSet Research Systems Inc.
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2Yr
5Yr
1 0Y r
3 0Y r
Inflation
Consumer Price Index (CPI)
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On an annual basis, CPI increased 2.7% in May versus
2.6% in April; core prices rose 2.2%.
Inflation
Personal Consumption Expenditures (PCE)
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Core PCE increased 1.9% in May, down from 2.0% in
April.
Inflation
Fed Funds Versus CPI
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Adequate spread between fed funds and the CPI is
arguably intact, suggesting that the Fed’s monetary
policy will remain unchanged.
Inflation
CRB Commodity Index
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Showing weakness, or at least is pulling back from
recent highs.
Inflation
Institute for Supply Management (ISM)
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Both ISM manufacturing and non-manufacturing are
reflecting growth.
Housing
Pending Home Sales of Existing Homes
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Pending sales of existing homes, a leading indicator
because it tracks contract signings, continues to trend
downward.
Housing
New Home Sales
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New home sales continue to decline.
Housing
Existing Home Sales
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Existing homes sales continue to trend downward.
Housing
Delinquencies
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Housing—subprime deterioration—remains a
predominant concern.
Housing
Conclusion
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Too early to conclude that housing has bottomed; the
housing environment remains challenging.
– Distinction between “weak” versus “collapse”
– Predominant view and evidence suggests potential for further
weakness.
– Company results:
• Home Depot cut its annual profit forecast, citing the slumping
U.S. housing market.
• Sears Holdings said its second quarter profit may decline by as
much as 46%.
• D.R. Horton said it will report a third quarter loss after orders
declined 40%.
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Implications and impact on consumer spending remain of
concern.
Earnings
S&P 500 Earnings Projections
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S&P 500 earnings growth is expected to modestly
accelerate in 2008.
Valuations are reasonable.
Earnings
S&P 500 Earnings Projections
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Earnings
S&P 500 Valuation Levels (July 2007)
S&P 500 Ind ex (Operating Basis) (SPX)
Pr i ce ( Ri g ht)
FY 1 Pr i ce/E arni ng s Rang e ( Left)
Aver ag e ( Left)
1500
28x
1400
26x
1300
24x
1200
1100
22x
1000
20x
900
18x
800
16x
14x
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Data Source: First Call Estimates
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Conclusion
Outlook
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Pro-growth thesis remains intact, driven largely by
favorable employment conditions and earnings outlook.
– Core U.S. inflation will remain contained; global growth and
foreign interest rates seem biased toward further upside.
– Economic expansion will continue, albeit at a slower rate.
• Housing, company earnings and employment are key.
– Fed is not likely to move until the fourth quarter, if at all in
2007.
– Adequate liquidity, increased merger and acquisition activity,
and attractive valuations present a favorable backdrop for
equities to outperform bonds.
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The Fed Stays The Course
• We believe, and Fed Funds Futures
corroborate the idea, that the Fed will be on
hold through the balance of the year.
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Credit Markets
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Sub-Prime woes continue to dominate credit markets
We don’t know the extent of the damage
Credit spreads are moving out
Caution is still warranted
Rates And The Curve
•Two stories here – domestic and global
•Domestic story is continued economic
expansion versus the housing drag
•Global story is focused on other central
banks raising rates and the need for a market
adjustment in US rates to continue to attract
capital
•Both stories at this juncture seem to point
toward mild upward pressure on US rates
•A risk to this view is a major sub-prime
event spurring a flight to quality
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The Muni Market
•Increased supply matched by new market
participants
•Spreads are tighter, but could tighten further
as new markets are assimilated
•International demand is present and
increasing
•Judicial issues on the horizon, but not
impacting the market as yet
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Final Thoughts
•Rates have a modest bias upward, but there
are overhanging fears of sub-prime fallout
•We appear to be in a new trading range – 5
year notes above 5.05% seem attractive
•Credit instruments still seem rich versus the
risk, but are adjusting
•The muni market continues to evolve and
become more dynamic – we believe that this
is and will continue to be positive and we
remain constructive on munis.
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