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May 09, 2005

Expert: Real estate decline fears ‘overblown' for 2005Mortgage PressHousing Bubble The early signs point to a solid year for U.S. investors and the economy in 2005, according to Barker French, Brinker Capital's chief investment strategist. In the latest quarterly forecast from the investment consulting firm, French said he expects to see 2005 end with 2.5 percent real gross domestic product growth, a two percent rise in productivity, profits up 11 percent, the S&P 500 rising 9-10 percent, oil closing just above $40 a barrel and the Federal Reserve Board interest rate at the relatively low level of 3.5 percent. "We are looking to see the economy and markets in 2005 shake off some of the doldrums that they went through in 2003 and 2004 and move forward in a solid if not dramatic fashion," said French. "While it is impossible to gauge in advance the potential impact of unpredictable factorssuch as another major terrorist attack on U.S. soil or the outbreak of further or new conflict in the Middle East or North Koreawe enter 2005 with an optimism that is less guarded than has been the case in past year. If there is a dark spot on the horizon, it is the continuing problems of the U.S. dollar, where we do not expect to see any meaningful improvement." In his forecast, French looked at specific issues and segments of the economy: Consumer debt Most reports indicate that household debt is at its highest level ever and there are fears that this may threaten consumer spending. Consumer spending has been responsible for two-thirds of economic activity. A precipitous drop in consumer spending would have significant consequences on business decisions and thus employment growth. "If you look at household debt as a percentage of personal disposable income, it is at its highest level ever. Current debt is 117 percent of personal disposable income (PDI). Going back to 1990, debt was about 80 percent of PDI," said French. "However, much of the consumer debt increase is mortgage debt. When you look at bank loan delinquency rates for consumer loans, you find that they have been falling. They were highest, 4.2 percent, in 1993. For 1997-2003, they hovered between 3.7 percent and 3.5 percent. By the end of 2004, delinquencies have fallen to 2.9 percent of all consumer loans. Clearly, the consumer is handling debt well." Housing According to French, "The fear of a housing collapse is overblown. There are pockets of excessive valuations, mostly on the east and west coasts. Selectively, there may be significant declines in prices but for the most part house prices are locally determined. It is highly unlikely that house prices across the U.S. would fall in unison. More likely, prices would stop rising and allow valuations to catch up. Further, it should be noted that delinquency rates for residential real estate, as a percentage of total bank loans, have been falling since 1990. In 1990, 3.2 percent of real estate loans were in default. Between 1995 and 2003, the percentage floated in the two percent to 2.4 percent range. During 2004, the percentage of loans delinquent fell to 1.6 percent." Business "I am glad to report that businesses are in great financial shape today," stated French. "Balance sheets are strong and clean." With economic indicators pointing towards continued growth, French predicted that profit growth for 2005 would be between six to 10 percent. Employment Noting that businesses paid a high price for over-hiring during the stock market expansion of the late 1990s, French said that companies have been working on raising productivity through technology and out sourcing, and have just begun to become net hirers again. "Jobs are the one variable that has seemingly lagged in the recovery," said French. "On the one hand, initial jobless claims have dropped to around a 310,000 average weekly level. Continuing claims have also trended lower and now are approximately 2,750,000 weekly. Total employment growth is averaging about two percent annually. The highest annual rate of growth in the 1990's was about four percent. So, employment is getting better." Inflation Economic indicators suggest that inflationary pressures may be building at the wholesale level and that high-energy prices have been the single most significant driver of inflation. "There is much uncertainty surrounding oil supply that is keeping prices high," commented French. "Our conclusion is that inflation will not be a recovery buster unless oil remains above $50 per barrel for an extended period of time." Interest rates Historically, the long-term inflation rate has been around 3.5 percent. During the past few years, the inflation rate has been much lower than that. In anticipation of inflation rising from low levels we currently experience back towards the norm, the Fed has been gradually raising interest rates. "The Fed's decision to begin an orderly increase in the rate moving it towards the equilibrium rate, estimated to be between 3.5 percent and four percent, is good policy," French said. "Good policy because gradual measured increases shouldn't adversely affect the economy and because a Fed Funds [rate] closer to the equilibrium rate affords the Fed an opportunity to lower rates if indeed the economy starts to stall." The dollar The dollar has fallen against the major currencies and appreciated slightly against minor currencies in emerging markets like China's, with which the U.S. has a major trade deficit. As the dollar drops in value and the price of goods from emerging markets fails to increase, the problem of the U.S. trade deficit with those markets is exacerbated. "What's the future outlook for the dollar? The 'bad' scenario, or a variant, suggests that consumers start a determined rebuilding of savings, undermining profits. Weaker U.S. demand curbs imports reducing the current account deficit," said French. "A weaker world economy affects export growth and results in a U.S. recession and a drop in the equity market. A variation might have the global pool of excess savings continue to fund the U.S. deficit, as it is doing now. We think the likely outcome is the bad scenario with the variation. There is an enormous amount of excess global savings and with European economies lagging, investors seem happy to buy U.S. investments." For more information, visit
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May 09, 2005
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