Valuation Opinions & Transaction Advisory Economic Update Q1 2014 www.mpival.com
Contents* 02 GDP Freezes Over Economic activity stalls in the first quarter, with weather taking some of the blame 03 Yellen Stays the Course The QE3 taper continues 04 Off on the Wrong Foot The housing market cools after a banner 2013 05 Labor Market Dilemma The unemployment rate continues to fall, but so does labor force participation 06 Outlook Economic forecasts and leading indicators 09 About * This publication is also available in soft copy on the website: www.mpival.com/newsletter.html. www.mpival.com 1
GDP Freezes Over Economic activity came to a stand-still in the first quarter, as real GDP registered growth of 0.1% according to the Bureau of Economic Analysis initial estimate. The general sentiment from analysts is that extremely harsh winter weather conditions had an adverse impact; however, the extent is unknown and debated among economists. Non-residential fixed investment, a measure of business capital expenditures, declined by 2.8% in the first quarter, a sign that weak fundamentals are playing a role as well. Although analysts expect economic activity to return to normalized levels in the coming quarters, geopolitical risks heightened in the first quarter, a dangerous development. Tensions have continued to escalate in Ukraine, where the strategic Crimean peninsula has effectively been annexed by Russia. Seemingly unfazed by worldwide condemnation and asset freezes of his top officials, Russian leader Vladimir Putin signed a bill to recognize Crimea as a Russian territory and continues to amass his forces along Ukraine s eastern border. Although the conflict has had limited impact on U.S. markets thus far, the standoff has the potential to grow into a full-scale war, which would have severe consequences for the global economy. Despite a relatively flat GDP reading in Q1, the one-time impact of severe weather has left 2014 projections in the 2%-3% range. If events in Ukraine escalate further, the global economy may be threatened 6% Real GDP % Change 4% 2% 0% -2% -4% -6% Sources: Bureau of Economic Analysis: Table 1.1.6 Real Gross Domestic Product, Chained 2009 Dollars, Quarterly, Seasonally Adjusted and Annualized Data. Federal Reserve Bank of Philadelphia: The Livingston Survey, December 2013 www.mpival.com 2
Yellen Stays the Course The Federal Reserve continued to gradually wind-down its asset purchase program in the first quarter. In Ben Bernanke s last meeting in January, Fed officials decided to reduce the pace of bondbuying by another $10 billion to $65 billion per month. Despite weakening economic data, newlyappointed Fed Chair Janet Yellen has thus far kept to the script, reducing asset purchases by another $10 billion to $55 billion per month at the Fed s March meeting. Equity markets were volatile in the first quarter, with the VIX rising to as high as 21, a level not seen since December 2012. Much of the volatility centered around the destabilization of developing markets caused by the Fed s wind-down of QE3. The Fed s continued reduction of QE3 despite recent market impacts may be a signal of the institution s unease with prolonging the unprecedented level of stimulus much further. On the other hand, it may also be a signal of the Fed s optimism regarding the strength of the U.S. economy to withstand suchvolatility. The S&P 500 overcame significant volatility to return slightly over 1% for the quarter... 2,000.00 1,900.00 1,800.00 1,700.00 1,600.00 1,500.00 1,400.00 1,300.00 1,200.00 Stock Market S&P 500 200 Day M.A. of S&P 500 CBOE Volatility Index 30 28 26 24 22 20 18 16 14 12 10 while interest rates, despite moderation in Q1, are expected to rise to more normalized levels as the Fed exits its bond-buying program Interest Rates 5.00% 4.50% 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% Ten-Year Treasury Note 30-Year Fixed Mortgage Rate Sources: S&P Capital IQ Chicago Board Options Exchange. "New Methodology: VIX Data for 2004 to Present. Federal Reserve Bank of St. Louis: FRED Economic Data, Thirty Year Fixed Rate Mortgage Average in the United States www.mpival.com 3
Off on the Wrong Foot 2013 was a banner year for the housing market which continued to recover from the devastation of the 2008-2009 financial collapse. However, a number of factors including a harsh winter, generally rising mortgage rates, and tight credit have led to a weak start to 2014 for the sector. Existing home sales in March were 7.5% below their level from a year earlier. According to Lawrence Yun, chief economist of the National Association of Realtors, housing activity is poised to recover in the second quarter: With ongoing job creation and some weather delayed shopping activity, home sales should pick up, especially if inventory continues to improve and mortgage interestrates rise only modestly. The housing market has cooled to begin the year, although one-time weather effects have contributed to the slowdown of existing home sales 5,800,000 5,600,000 5,400,000 5,200,000 5,000,000 4,800,000 4,600,000 4,400,000 4,200,000 Existing Home Sales Existing Home Sales (number of units) Two-Year Moving Average while mortgage interest rates leveled off, yet remained elevated in comparison to a year prior 5.00% 30-Year Fixed Mortgage Rate 4.50% 4.00% 3.50% 3.00% Source: Federal Reserve Bank of St. Louis: FRED Economic Data, Existing Home Sales, Monthly, Seasonally Adjusted Annual Rate and Thirty Year Fixed Rate Mortgage Average in the United States www.mpival.com 4
Labor Market Dilemma After reaching a high of 10.1% in October 2009, the unemployment rate has gradually decreased to 6.7% at the end of the first quarter. Economic recoveries have been weaker following financial crisisinduced recessions than typical business cycle recessions throughout U.S. history, as has been the case with our current slow-paced turn around. Although the declining unemployment rate is encouraging and a sign that the recovery is moving forward, expectations must be tempered. The decline in the unemployment rate is in part due to a historically low labor force participation rate. Additionally, the official unemployment rate does not include discouraged workers and part-time workers who would prefer full-time jobs. When these two groups are included in themeasure (U-6 rate), unemploymentstood at 12.7% at theend of Q1. The official unemployment rate registered at 6.7% at the end of the first quarter, as the recovery moves forward 20.00% 18.00% Unemployment Rate Unemployment Rate U-6 Rate 16.00% 14.00% 12.00% 10.00% 8.00% 6.00% however, the labor force participation rate remains at historically low levels 68.00% Labor Force Participation Rate 67.00% 66.00% 65.00% 64.00% 63.00% 62.00% Sources: Bureau of Labor Statistics: Employment Situation News Release Federal Reserve Bank of St. Louis: FRED Economic Data, Civilian Labor Force Participation Rate, Monthly, Seasonally Adjusted www.mpival.com 5
Outlook Economic forecasters remain cautiously optimistic about U.S. growth prospects going forward. Federal Reserve Board members and Federal Reserve Bank presidents together project growth of 2.8%-3.0% in 2014. Leading economic indicators have generally moderated since the end of 2013, yet remain positive. The Conference Board s Leading Economic Index, a composite index of ten leading indicators, continued its rise in Q1, indicating stronger growth going forward 104.0 102.0 Aggregate Leading Economic Indicators Conference Board Leading Economic Index Two-Year Moving Average 100.0 98.0 96.0 94.0 92.0 90.0 88.0 and new orders, despite some moderation, remained in expansion territory 70 65 ISM New Orders Index* Manufacturing Non-Manufacturing 60 55 50 45 40 *Readings above 50 indicate expansion. Readings below 50 indicate contraction. Sources: Bloomberg Federal Reserve Bank of St. Louis: FRED Economic Data: ISM Manufacturing: New Orders Index, ISM Non-Manufacturing: New Orders Index www.mpival.com 6
Outlook (continued) In similar fashion to the new orders indices, the New York and Philadelphia regional indices fell in Q1, yet continued to indicate economic expansion going forward 70.0 60.0 Expected Future Manufacturing Activity in the Mid-Atlantic* Empire State Future General Business Conditions Philadelphia Federal Reserve Future Activity Index 50.0 40.0 30.0 20.0 10.0 0.0 *Positive readings indicate expansion. while leading housing indicators remain above their respective two-year moving averages 1,200 1,100 New Residential Construction Building Permits (Thousands) Housing Starts (Thousands) Two-Year M.A. Permits (Thousands) Two-Year M.A. Housing Starts (Thousands) 1,000 900 800 700 600 and consumers became less optimistic than at year-end, yet sentiment remained above the two-year moving average 90 85 Consumer Sentiment Thomson Reuters/U of Mich. Consumer Sentiment Index Two-Year Moving Average 80 75 70 65 Sources: Federal Reserve Bank of Philadelphia: Business Outlook Survey Historical Data Federal Reserve Bank of New York: Empire State Manufacturing Survey Federal Reserve Bank of St. Louis: FRED Economic Data, University of Michigan: Consumer Sentiment Federal Reserve Bank of St. Louis: FRED Economic Data, Housing Starts Total: New Privately Owned Housing Units Started and New Private Housing Units Authorized by Building Permits www.mpival.com 7
Outlook (continued) Corresponding to estimates of continued moderate economic growth, Federal Reserve officials project a continued gradual decline in the unemployment rate to 6.1%-6.3% by the fourth quarter of 2014. Leading labor market indicators strengthenedin Q1. Initial jobless claims continued to fall in Q1, to 321,000 in the last week of March 470,000 450,000 430,000 410,000 390,000 370,000 350,000 330,000 310,000 290,000 Initial Jobless Claims Initial Jobless Claims (Weekly, Seasonally Adjusted) Two-Year Moving Average and manufacturing weekly hours rose to 42 in March, pointing to a continued pick-up in hiring 42.2 42.1 42.0 41.9 41.8 41.7 41.6 41.5 41.4 41.3 Manufacturing: Average Weekly Labor Hours Manufacturing Average Weekly Hours (Production and Non-Supervisory) Two-Year Moving Average Sources: Federal Reserve Bank of St. Louis: FRED Economic Data, Initial Claims Federal Reserve Bank of St. Louis: FRED Economic Data, Average Weekly Hours of Production and Nonsupervisory Employees: Manufacturing www.mpival.com 8
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