1. Peering Through the Mist
Strategic Investor Conference - La Jolla
April 22-24, 2004
Peering Through the Mist
Martin Barnes
Managing Editor
The Bank Credit Analyst

2. KEY MESSAGES The U.S. economic expansion is sustainable.
The Fed is falling behind the curve: inflation will pick up in the coming year.
The trends in domestic debt are unsustainable, but do not pose any immediate threat to the economic and financial outlook.
No major asset class offers compelling value right now. However, stocks should outperform both bonds and cash this year and next.

3. REFLATION TRADES (Part I)
STOCK-TO-BOND TOTAL RETURN RATIO*
1.0
1.0 .9 .9 .8 .8 .7 .7 .6 .6
BPs
BPs
CORPORATES MINUS TREASURYS (OAS)**
240
240
200
200
160
160
120
120
© BCA Research 2004
2001
2002
2003
*INDEXED TO JANUARY 2001 = 1
**SOURCE: MERRILL LYNCH; OPTION-ADJUSTED SPREAD

4. REFLATION TRADES (Part II)
S&P CYCLICAL STOCKS/NON-CYCLICAL STOCKS
1.0
1.0 .9 .9 .8 .8 .7 .7 .6 .6
320
CRB* RAW INDUSTRIALS INDEX
320
300
300
40-WEEK MOVING AVERAGE
280
280
260
260
240
240
220
220
© BCA Research 2004
2001
2002
2003
*CRB = COMMODITY RESEARCH BUREAU

5. MASSIVE MONETARY STIMULUS% %
FED FUNDS TARGET RATE 10
GDP GROWTH 10 8 8 6 6 4 4 2 2
© BCA Research 2004
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004

6. STRONG REVIVAL IN BUSINESS CONFIDENCE% %
AVERAGE OF ISM MANUFACTURING AND NON-MANUFACTURING INDEXES* 60 60 55 55 50 50 45 45 40 40
CONFERENCE BOARD BUSINESS CONFIDENCE INDEX 70 70 60 60 50 50 40 40 30 30
© BCA Research 2004
1998
1999
2000
2001
2002
2003
2004
*SOURCE: INSTITUTE FOR SUPPLY MANAGEMENT

7. CONSUMER SPENDING SUPPORTED BY INCOMES
Ann% Chg
Ann% Chg
REAL PERSONAL DISPOSABLE INCOME*
REAL CONSUMER SPENDING* 6 6 4 4 2 2 % %
PERSONAL SAVING RATE* 4 4 3 3 2 2 1 1
© BCA Research 2004
1996
1998
2000
2002
2004
*SHOWN AS A 3-MONTH MOVING AVERAGE

8. HEALTHY TREND IN CONSUMER INCOMES
Ann% Chg
Ann% Chg
DISPOSABLE INCOME 8
PERSONAL INCOME 8 6 6 4 4 2 2 % %
AVERAGE EFFECTIVE TAX RATE 14 14 12 12 10 10
© BCA Research 2004
1998
2000
2002
2004
NOTE: ALL SERIES ARE SHOWN AS A 3-MONTH MOVING AVERAGE

9. A GLOBAL RECOVERY
Ann% Chg
U.S.:
LEADING ECONOMIC INDICATOR (LS)
INDUSTRIAL PRODUCTION (RS)
102 4
101
100 -4 99
BCA GLOBAL LEADING ECONOMIC INDICATOR EX. U.S. (LS)
GLOBAL INDUSTRIAL PRODUCTION EX. U.S. (RS) .4 8 4
-.4
-.8
© BCA Research 2004 -4
1994
1996
1998
2000
2002
2004

10. RECESSIONS USUALLY TRIGGERED BY TIGHT MONEY
Ann% Chg
Ann% Chg
REAL GDP 6 6 4 4 2 2 -2 -2 % %
10-YEAR MINUS 3-MONTH TREASURY YIELD 4 4 2 2 -2 -2
© BCA Research 2004
1960
1965
1970
1975
1980
1985
1990
1995
2000
NOTE: SHADED AREAS CORRESPOND TO NBER-DESIGNATED PERIODS OF RECESSION

11. A STUNNING REBOUND IN PROFITS% %
TOTAL CORPORATE AFTER-TAX PROFITS AS A % OF GDP 8 8 7 7 6 6 5 5 4 4 %
NON-FINANCIAL CORPORATE SECTOR: %
WEIGHTED AVERAGE REAL COST OF CAPITAL 9 9
AVERAGE RETURN ON CAPITAL 8 8 7 7 6 6 5 5 4 4 3 3
© BCA Research 2004
1960
1965
1970
1975
1980
1985
1990
1995
2000

12. INFLATION TURNS THE CORNER
Ann% Chg
Ann% Chg
CORE* CPI
2.5
2.5
2.0
2.0
1.5
1.5
Ann% Chg
CORE* PPI FINISHED GOODS
Ann% Chg 2 2 1 1
Ann% Chg
Ann% Chg
IMPORT PRICES FOR CONSUMER GOODS & AUTOS 2 2 1 1 -1 -1
© BCA Research 2004
1994
1996
1998
2000
2002
2004
*CORE EXCLUDES FOOD AND ENERGY

13. THE TWO SIDES OF INFLATION
Ann% Chg
Ann% Chg
CORE* CPI GOODS -2 -2
Ann% Chg
CORE* CPI SERVICES EXCLUDING RENT OF SHELTER
Ann% Chg 4 4 3 3
© BCA Research 2004
1994
1996
1998
2000
2002
2004
*CORE EXCLUDES FOOD AND ENERGY

14. IS HOUSING IN A BUBBLE? HOUSE PRICES* / EMPLOYEE COMPENSATION RATIO
2.0
2.0
1.9
1.9
1.8
1.8
1.3
HOUSE PRICES* / CPI RENT OF SHELTER
1.3
1.2
1.2
1.1
1.1
© BCA Research 2004
1984
1988
1992
1996
2000
2004
*SOURCE: OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT

15. IS HOUSING IN A BUBBLE? HOUSE PRICES* 8 8 6 6 4 4 2 2 140
Ann% Chg
Ann% Chg
HOUSE PRICES* 8 8 6 6 4 4 2 2
140
HOUSING AFFORDABILITY INDEX**
140
120
120
100
100 80 80
© BCA Research 2004
1982
1986
1990
1994
1998
2002
*SOURCE: OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT
**SOURCE: NATIONAL ASSOCIATION OF REALTORS

16. IS CONSUMER DEBT A PROBLEM?% %
HOUSEHOLD DEBT AS A % OF
PERSONAL DISPOSABLE INCOME
100
100 90 90 80 80 70 70 60 60 50 50
© BCA Research 2004
1960
1970
1980
1990
2000

17. “Consumer short term debt… is approaching a historical turning point
“Consumer short term debt… is approaching a historical turning point. Having risen at an abnormally fast rate for ten years, it must soon adjust itself to the nation’s capacity for going into hock… which is not limitless. Whether the rate of growth in consumer debt will slow down is no longer the question…it must slow down.”
Fortune Magazine March 1956
“Federal Reserve Chairman G. William Miller said the average American buyer is getting dangerously deep in debt, and warned that the trend could have serious consequences… Several of the nation’s business leaders said they share Miller’s alarm over the level to which consumer debts have climbed.”
Washington Post October 1978

18. CONSUMERS NOT IN FINANCIAL STRESS% %
BANK LOAN DELINQUENCY RATES:
3.2
3.2
2.8
RESIDENTIAL REAL ESTATE LOANS
2.8
2.4
2.4
2.0
2.0 % %
4.2
4.2
ALL CONSUMER LOANS
3.8
3.8
3.4
3.4
3.0
3.0
2.6
2.6
© BCA Research 2004
1990
1992
1994
1996
1998
2000
2002
2004

19. TREASURYS ARE OVERVALUED% %
10-YEAR TREASURY YIELD 9 9
FAIR VALUE PROJECTED BY BCA BOND MODEL 8 8 7 7 6 6 5 5 4 4
BCA 10-YEAR TREASURY VALUATION INDEX
Bonds Extremely Undervalued 1 1 -1 -1
Bonds Extremely Overvalued -2 -2
© BCA Research 2004
1990
1992
1994
1996
1998
2000
2002
2004

20. STOCKS ARE NOT CHEAP 25 25
S&P 500 FORWARD P/E RATIO* 20 20 15 15 10 10 5 5
NONFINANCIAL CORPORATE SECTOR EQUITIES TO REPLACEMENT COST BOOK VALUE
1.6
1.6
1.2
1.2 .8 .8 % %
S&P 500 DIVIDEND YIELD MINUS 3-MONTH TREASURY BILL YIELD -4 -4 -8 -8
-12
-12
© BCA Research 2004
1980
1984
1988
1992
1996
2000
2004
*BASED ON 12-MONTH FORWARD EARNINGS

21. STILL LOTS OF CASH ON THE SIDELINES% % 60 60
CASH MOUNTAIN* AS A % OF PERSONAL DISPOSABLE INCOME 50 50 40 40 30 30
Bn$
Bn$
INTEREST INCOME FROM CASH MOUNTAIN* (IN 2003 PRICES)
220
220
180
180
140
140
100
100 60 60
© BCA Research 2004
1982
1986
1990
1994
1998
2002
*INCLUDES MONEY MARKET FUNDS AND SAVINGS DEPOSITS

22. Mean- Reversion Scenario**
DECOMPOSING EQUITY MARKET RETURNS
Mean- Reversion Scenario**
Historical Average
Bubble Years
Bear Market
Optimistic Scenario
Bear Scenario*** *
Nominal GDP
Earnings +Valuation change =Growth in S&P 500 +Reinvested dividends =Total equity returns Inflation (CPI) Real returns
*Bull market ended in 2000 Q3, based on quarterly data. ** Assumes that the price-earnings ratio falls to 15 over the period. ***Assumes that the price-earnings ratio falls to 12 over the period.
© BCA Research 2004

23. THE DOLLAR MOVES IN LONG CYCLES
REAL TRADE-WEIGHTED DOLLAR
130
130
120
120
110
110
100
100 90 90
© BCA Research 2004
1975
1980
1985
1990
1995
2000
SOURCE: THE FEDERAL RESERVE

24. WHY THE DOLLAR HAS FURTHER TO FALL% %
CURRENT ACCOUNT DEFICIT AS A % OF GDP 5 5
NET LONG-TERM CAPITAL FLOWS AS A % OF GDP
(PORTFOLIO PLUS DIRECT INVESTMENT)* 4 4 3 3 2 2 1 1 -1 -1
© BCA Research 2004
1980
1984
1988
1992
1996
2000
2004
*SHOWN AS A 4-QUARTER MOVING AVERAGE

25. GOLD AS A LONG-TERM INVESTMENT
4000
4000
REAL RETURN ON:
2000
2000
STOCKS
1000
1000
BONDS
500
GOLD
500
100
100 10 10
© BCA Research 2004
1880
1900
1920
1940
1960
1980
2000