Economic Review and Economic Review and OutlookOutlook

University of PhoenixUniversity of PhoenixJanuary 23, 2008January 23, 2008David B. JohnsonDavid B. Johnson

ZHP CapitalZHP Capital

The Fed’s DilemmaThe Fed’s Dilemma

What they say... What they mean...

2007 Economic Review2007 Economic Review and Outlook for 2008 and Outlook for 2008

2006 2007

(or last 12 months

available)

4th Quarter

(or last available)

WSJ Forecast Range

WSJ Forecast

Mean

Federal Reserve’s

FOMC

GDP (thru 3Q 2007) 2.9% 2.3% 4.9% -0.4% - 5.0% 2.0% 1.8% - 2.5%

Unemployment Rate (Year-end)

4.4% 5.0% 4.8% 4.3% - 6.0% 5.2% 4.8% - 4.9%

Payrolls +2.3 million +1.3 million +292,000 -660,000 – 2,300,000

894,000

CPI 2.5% 4.1% 5.6% 0.6% - 3.5% 2.3% 1.8% - 2.1%

Housing Starts 1,800,900 1,353,700 1,151,000 0.8 – 1.35 mm 1,100,000

Fed Funds Target

avg: 4.96% Y/E: 5.25%

5.02% 4.25%

4.50% 4.25%

2.0% - 5.5% 3.65%

10 year Tsy Yield(Year-end)

avg: 4.79% Y/E: 4.71%

4.63% 4.03%

4.26% 4.03%

3.5% - 5.5% 4.40%

Mortgage Rates

6.41% 6.34% 6.23% N/A N/A

S&P 500 Index:1418.30 % Chg: 15.8%

1468.36 +5.5%

1468.36 -3.8%

N/A N/A

Question #1Question #1

In 2007, single-family housing starts In 2007, single-family housing starts fell 25%, and home prices are likely fell 25%, and home prices are likely to see their first national decline to see their first national decline since 1930’s.since 1930’s.

In 2008, will this housing “pandemic” In 2008, will this housing “pandemic” give the rest of the economy the give the rest of the economy the “flu”, or just a “cold”?“flu”, or just a “cold”?

Recession ProbabilityRecession Probability

Odds of Recession in next 12 monthsWSJ Survey of Economists

0%5%

10%15%20%

25%30%35%

40%45%

Survey Month

Lik

eli

ho

od

(%

)

Business Cycle ExpansionsBusiness Cycle Expansions and Contractions and Contractions

Peak to

Trough

Previous trough to peak

Trough from

Previous Trough

Peak from

Previous Peak

Average, all cycles: 1854-2001 (32 cycles) 1854-1919 (16 cycles) 1919-1945 (6 cycles) 1945-2001 (10 cycles)

17 22 18 10

38 27 35 57

55 48 53 67

56* 49** 53 67

* 31 cycles ** 15 cycles

Source: NBER

“A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

Subprime MortgagesSubprime Mortgages

The subprime category of residential mortgages typically includes loans made to borrowers that displayed one or more of the following characteristics at the time of origination:• weakened credit• histories that include payment delinquencies,

chargeoffs, judgments, and/or bankruptcies; • Reduced repayment capacity as measured by

credit scores or debt-to-income ratios;• or incomplete credit histories.

Source: July 2007 Senior Loan Officer Opinion Survey on Bank Lending Practices

Housing StartsHousing Starts

Housing Price ChangesHousing Price Changes

OFHEO Repeat SalesS&P/Case-Schiller Existing Home

Prices

Job CreationJob Creation

Jobs vs. IncomeJobs vs. Income

Non-farm Payrolls (LH)

Personal Income (RH)

Jobs vs. SpendingJobs vs. Spending

Non-farm Payrolls (LH)

Personal Consumption (RH)

?

Business Capital SpendingBusiness Capital Spending

Capital Goods Orders

Industrial Production

Purchasing Manager’s IndexPurchasing Manager’s Index

Question #2Question #2

In 2007, the Federal Reserve lowered the In 2007, the Federal Reserve lowered the target Federal Funds rate by 100 basis target Federal Funds rate by 100 basis points, and instituted several points, and instituted several extraordinary programs to provide liquidity extraordinary programs to provide liquidity and credit to the capital markets.and credit to the capital markets.

In 2008, will the Federal Reserve continue to In 2008, will the Federal Reserve continue to stoke the monetary fires, raising the risk of stoke the monetary fires, raising the risk of a resurgence of inflation?a resurgence of inflation?

Federal Reserve Policy ToolsFederal Reserve Policy ToolsRecent ChangesRecent Changes

8/17 Discount Rate Cut

9/18 - 50 basis point Fed Funds and Discount Rate Cut

10/31 & 12/1125 basis point Fed Funds and Discount Rate Cuts 1/22 - 75 basis

point Fed Funds and Discount Rate Cut

FOMC Monetary PolicyFOMC Monetary Policy

Source: St. Louis Federal Reserve, Monetary Trends

Tight Money

Easy Money

Money Still Matters?Money Still Matters?

?

Inflation ExpectationsInflation Expectations

Measures of Inflation Expectations

0.0

1.0

2.0

3.0

4.0

5.0

Date

Pe

rce

nta

ge

R

ate

SPF 1 Year Forward

Univ of Michigan Consumer Survey

Yld Difference 10 Year Tsy Note and 10 Year TIPS

Question #3Question #3

In 2007, the exchange value of the US In 2007, the exchange value of the US dollar fell to 30 year lows against the dollar fell to 30 year lows against the currencies of our major trading currencies of our major trading partners.partners.

In 2008, will strong foreign economies In 2008, will strong foreign economies and this weak dollar generate and this weak dollar generate enough exports to support the US enough exports to support the US economy?economy?

Exchange RatesExchange Rates

$0.90/euro

$1.46/euro

Outlook for Fiscal StimulusOutlook for Fiscal Stimulus

Bush has proposed $150 billion packageBush has proposed $150 billion package Any fiscal stimulus could be counter-Any fiscal stimulus could be counter-

productive if not implemented in a timely or productive if not implemented in a timely or efficient mannerefficient manner• Must provide stimulus promptly in next 12 Must provide stimulus promptly in next 12

monthsmonths• Must maximize near-term stimulus per dollar of Must maximize near-term stimulus per dollar of

increased budget expenseincreased budget expense• Must be explicitly temporary to avoid Must be explicitly temporary to avoid

exacerbating the structural deficit.exacerbating the structural deficit.

Current ConditionsCurrent Conditions Fed’s Beige Book for Chicago DistrictFed’s Beige Book for Chicago District

• Economic Activity expanded at slow pace in December Economic Activity expanded at slow pace in December and early Januaryand early January

• Consumer spending mixed, with vehicle inventories Consumer spending mixed, with vehicle inventories declining to comfortable levelsdeclining to comfortable levels

• Business Spending little changed from previousBusiness Spending little changed from previous• Residential construction and home sales declined. Real Residential construction and home sales declined. Real

estate lending remains weak, but defaults were not estate lending remains weak, but defaults were not deteriorating.deteriorating.

• Manufacturing growth was stable, and manufacturers Manufacturing growth was stable, and manufacturers remained upbeat about prospects for 2008. Strength in remained upbeat about prospects for 2008. Strength in demand for exports and falling dollar has allowed price demand for exports and falling dollar has allowed price increases.increases.

• Rising input costs for manufacturers, especially for those Rising input costs for manufacturers, especially for those affected by oil, with a general inability to pass on costs.affected by oil, with a general inability to pass on costs.

• Higher wholesale food prices were able to be passed on Higher wholesale food prices were able to be passed on to retail food consumers.to retail food consumers.

So what does this mean for So what does this mean for Business?Business?

Prepare for a greater slowdown in Prepare for a greater slowdown in final sales in the coming months.final sales in the coming months.

Pricing power will be limitedPricing power will be limited Borrowing rates should fall Borrowing rates should fall

dramatically, especially for prime dramatically, especially for prime borrowers.borrowers.

Economic Review and Economic Review and OutlookOutlook

University of PhoenixUniversity of PhoenixJanuary 23, 2008January 23, 2008David B. JohnsonDavid B. Johnson

ZHP CapitalZHP Capital