Martin BarnesManaging EditorThe Bank Credit Analyst

Peering Through the Mist

Strategic Investor Conference - La Jolla

April 22-24, 2004

KEY MESSAGES

1. The U.S. economic expansion is sustainable.

2. The Fed is falling behind the curve: inflation will pick up in the coming year.

3. The trends in domestic debt are unsustainable, but do not pose any immediate threat to the economic and financial outlook.

4. No major asset class offers compelling value right now. However, stocks should outperform both bonds and cash this year and next.

REFLATION TRADES (Part I)

240

200

160

120

2001 2002 2003

240

200

160

120

1.0

.9

.8

.7

.6

1.0

.9

.8

.7

.6

CORPORATES MINUS TREASURYS (OAS)**

BPs BPs

STOCK-TO-BOND TOTAL RETURN RATIO*

*INDEXED TO JANUARY 2001 = 1 **SOURCE: MERRILL LYNCH; OPTION-ADJUSTED SPREAD

© BCA Research 2004

REFLATION TRADES (Part II)

© BCA Research 2004

320300280

260

240

220

2001 2002 2003

320300280

260

240

220

1.0

.9

.8

.7

.6

1.0

.9

.8

.7

.6

CRB* RAW INDUSTRIALS INDEX

40-WEEK MOVING AVERAGE

S&P CYCLICAL STOCKS/NON-CYCLICAL STOCKS

*CRB = COMMODITY RESEARCH BUREAU

MASSIVE MONETARY STIMULUS

© BCA Research 2004

10

8

6

4

2

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

10

8

6

4

2

FED FUNDS TARGET RATEGDP GROWTH

% %

STRONG REVIVAL IN BUSINESS CONFIDENCE

© BCA Research 2004

70

60

50

40

30

1998 1999 2000 2001 2002 2003 2004

70

60

50

40

30

60

55

50

45

40

60

55

50

45

40

CONFERENCE BOARDBUSINESS CONFIDENCE INDEX

AVERAGE OF ISM MANUFACTURING AND NON-MANUFACTURING INDEXES*

% %

*SOURCE: INSTITUTE FOR SUPPLY MANAGEMENT

CONSUMER SPENDING SUPPORTED BY INCOMES

© BCA Research 2004

4

3

2

1

1996 1998 2000 2002 2004

4

3

2

1

6

4

2

6

4

2

PERSONAL SAVING RATE*% %

REAL CONSUMER SPENDING*REAL PERSONAL DISPOSABLE INCOME*

Ann%Chg

*SHOWN AS A 3-MONTH MOVING AVERAGE

Ann%Chg

HEALTHY TREND IN CONSUMER INCOMES

© BCA Research 2004

14

12

10

1998 2000 2002 2004

14

12

10

8

6

4

2

8

6

4

2

AVERAGE EFFECTIVE TAX RATE%

PERSONAL INCOMEDISPOSABLE INCOME

NOTE: ALL SERIES ARE SHOWN AS A 3-MONTH MOVING AVERAGE

Ann%Chg

Ann%Chg

%

A GLOBAL RECOVERY

© BCA Research 2004

.4

0

-.4

-.8

1994 1996 1998 2000 2002 2004

8

4

0

-4

102

101

100

99

4

0

-4

BCA GLOBAL LEADING ECONOMIC INDICATOR EX. U.S. (LS)GLOBAL INDUSTRIAL PRODUCTION EX. U.S. (RS)

U.S.: LEADING ECONOMIC INDICATOR (LS)INDUSTRIAL PRODUCTION (RS)

Ann%Chg

RECESSIONS USUALLY TRIGGERED BY TIGHT MONEY

© BCA Research 2004

4

2

0

-2

1960 1965 1970 1975 1980 1985 1990 1995 2000

4

2

0

-2

6

4

2

0

-2

6

4

2

0

-2

10-YEAR MINUS 3-MONTH TREASURY YIELD% %

REAL GDP

NOTE: SHADED AREAS CORRESPOND TO NBER-DESIGNATED PERIODS OF RECESSION

Ann%Chg

Ann%Chg

A STUNNING REBOUND IN PROFITS

© BCA Research 2004

9876543

1960 1965 1970 1975 1980 1985 1990 1995 2000

9876543

8

7

6

5

4

8

7

6

5

4NON-FINANCIAL CORPORATE SECTOR:

WEIGHTED AVERAGE REAL COST OF CAPITALAVERAGE RETURN ON CAPITAL

% %

TOTAL CORPORATE AFTER-TAX PROFITS AS A % OF GDP

% %

INFLATION TURNS THE CORNER

© BCA Research 2004

2 1 0-1

1994 1996 1998 2000 2002 2004

2 1 0-1

2

1

0

2

1

0

2.5

2.01.5

2.5

2.01.5

IMPORT PRICES FOR CONSUMER GOODS & AUTOS

CORE* PPI FINISHED GOODS

CORE* CPI

*CORE EXCLUDES FOOD AND ENERGY

Ann%Chg

Ann%Chg

Ann%Chg

Ann%Chg

Ann%Chg

Ann%Chg

THE TWO SIDES OF INFLATION

© BCA Research 2004

4

3

1994 1996 1998 2000 2002 2004

4

3

0

-2

0

-2

CORE* CPI SERVICESEXCLUDING RENT OF SHELTER

CORE* CPI GOODS

*CORE EXCLUDES FOOD AND ENERGY

Ann%Chg

Ann%Chg

Ann%Chg

Ann%Chg

IS HOUSING IN A BUBBLE?

© BCA Research 2004

1.3

1.2

1.1

1984 1988 1992 1996 2000 2004

1.3

1.2

1.1

2.0

1.9

1.8

2.0

1.9

1.8

HOUSE PRICES* / CPI RENT OF SHELTER

HOUSE PRICES* / EMPLOYEECOMPENSATION RATIO

*SOURCE: OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT

IS HOUSING IN A BUBBLE?

© BCA Research 2004

140

120

100

80

1982 1986 1990 1994 1998 2002

140

120

100

80

8

6

4

2

8

6

4

2

HOUSING AFFORDABILITY INDEX**

HOUSE PRICES*

*SOURCE: OFFICE OF FEDERAL HOUSING ENTERPRISE OVERSIGHT**SOURCE: NATIONAL ASSOCIATION OF REALTORS

Ann%Chg

Ann%Chg

IS CONSUMER DEBT A PROBLEM?

100

90

80

70

60

50

1960 1970 1980 1990 2000

100

90

80

70

60

50

HOUSEHOLD DEBT AS A % OF PERSONAL DISPOSABLE INCOME

% %

© BCA Research 2004

“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 MagazineMarch 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 PostOctober 1978

CONSUMERS NOT IN FINANCIAL STRESS

© BCA Research 2004

4.2

3.8

3.4

3.0

2.6

1990 1992 1994 1996 1998 2000 2002 2004

4.2

3.8

3.4

3.0

2.6

3.2

2.8

2.4

2.0

3.2

2.8

2.4

2.0

ALL CONSUMER LOANS

% %

RESIDENTIAL REAL ESTATE LOANS

BANK LOAN DELINQUENCY RATES:% %

TREASURYS ARE OVERVALUED

© BCA Research 2004

1

0

-1

-2

1990 1992 1994 1996 1998 2000 2002 2004

1

0

-1

-2

987654

987654

BCA 10-YEAR TREASURY VALUATION INDEXBonds Extremely Undervalued

10-YEAR TREASURY YIELDFAIR VALUE PROJECTED BY BCA BOND MODEL

% %

Bonds Extremely Overvalued

STOCKS ARE NOT CHEAP

© BCA Research 2004

0

-4

-8

-12

1980 1984 1988 1992 1996 2000 2004

0

-4

-8

-12

1.61.2 .8

1.61.2 .8

25

20

15

10

5

25

20

15

10

5

S&P 500 DIVIDEND YIELD MINUS 3-MONTH TREASURY BILL YIELD% %

NONFINANCIAL CORPORATE SECTOR EQUITIES TO REPLACEMENT COST BOOK VALUE

S&P 500 FORWARD P/E RATIO*

*BASED ON 12-MONTH FORWARD EARNINGS

STILL LOTS OF CASH ON THE SIDELINES

© BCA Research 2004

220

180

140

100

601982 1986 1990 1994 1998 2002

220

180

140

100

60

60

50

40

30

60

50

40

30

INTEREST INCOME FROM CASH MOUNTAIN*(IN 2003 PRICES)

Bn$ Bn$

CASH MOUNTAIN* AS A % OF PERSONAL DISPOSABLE INCOME

% %

*INCLUDES MONEY MARKET FUNDS AND SAVINGS DEPOSITS

DECOMPOSING EQUITY MARKET RETURNS

© BCA Research 2004

Historical Average 1950-95

Bubble Years

Bear Market 2000-02

Optimistic Scenario

Mean- Reversion Scenario**

Bear Scenario***

2004-142004-142004-14

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.

7.6

7.6

1.4

9.0

4.3

13.3

4.2

8.7

5.9

9.3

13.7

23.0

2.0

25.0

2.2

22.3

3.2

-8.7

-5.9

-14.6

1.7

-12.9

2.4

-14.9

5.0

5.0

0.0

5.0

1.7

6.7

2.0

5.7

5.0

5.0

-1.8

3.2

1.7

4.9

2.0

4.1

5.0

5.0

-4.0

1.0

1.7

2.7

2.0

1.8

1996-2000*

THE DOLLAR MOVES IN LONG CYCLES

© BCA Research 2004

130

120

110

100

90

1975 1980 1985 1990 1995 2000

130

120

110

100

90

REAL TRADE-WEIGHTED DOLLAR

SOURCE: THE FEDERAL RESERVE

WHY THE DOLLAR HAS FURTHER TO FALL

© BCA Research 2004

5

4

3

2

1

0-1

1980 1984 1988 1992 1996 2000 2004

5

4

3

2

1

0

-1

CURRENT ACCOUNT DEFICIT AS A % OF GDPNET LONG-TERM CAPITAL FLOWS AS A % OF GDP(PORTFOLIO PLUS DIRECT INVESTMENT)*

% %

*SHOWN AS A 4-QUARTER MOVING AVERAGE

GOLD AS A LONG-TERM INVESTMENT

© BCA Research 2004

400020001000 500

100

10

1880 1900 1920 1940 1960 1980 2000

400020001000 500

100

10

REAL RETURN ON:

STOCKSBONDSGOLD