US Economic Outlook IHS ECONOMICS & COUNTRY RISK. Global Economics & Country Risk Conference

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1 IHS ECONOMICS & COUNTRY RISK Global Economics & Country Risk Conference US Economic Outlook How long will the ride last? November 2014 ihs.com Douglas Handler, IHS Chief US Economist, , 2014 IHS

2 US Outlook/ November 2014 Executive Summary - economic growth accelerates a notch from 2.2% in 2014 to 2.6% in 2015 Adverse demographics drive labor force supply and household formation Energy and gasoline prices create a consumer dividend, but somewhat eroded by high food prices and adverse international trade conditions International trade will determine whether future US growth is merely average or better or worse than average Productivity and capital spending drive next year s gains Risks to the forecast: Slower non-us growth affect exports Faster domestic growth and a rising dollar promote import substitution Demographic impacts prove to be deeper than originally thought Productivity growth remains recession-like Adverse reactions to prospective Fed tightening in 2015 damage consumer and business sentiment 2014 IHS 2

3 Excluding the trade and government sectors, economic growth isn t looking too bad Real GDP growth measures (annualized percent change) US Outlook/ November Source: IHS Real GDP 2014 IHS 2014 IHS 3

4 Fourth quarter real GDP growth will be dragged down by exports and defense spending surges from q3 Contributions to real GDP growth US Outlook/ November 2014 Annualized percentage change Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 Real GDP Consumer spending Fixed investment Housing Inventories Exports Imports Government Source: IHS 2014 IHS 2014 IHS 4

5 Looking forward, we will still be counting on consumer spending to drive the bulk of economic growth Contributions to real GDP growth US Outlook/ November 2014 Annualized percentage change Real GDP Consumer spending Fixed investment Housing Inventories Exports Imports Government Source: IHS 2014 IHS 2014 IHS 5

6 US Outlook/ November 2014 Employment, Inflation, and Interest Rates 2014 IHS 6

7 Is the labor market getting tight enough to drive wage pressures? Job creation and the unemployment rate US Outlook/ November 2014 Number of new jobs (000s) Unemployment rate (%) Employment growth Unemployment rate Source: IHS 2014 IHS 2014 IHS 7

8 US Outlook/ November 2014 Where did the labor force growth go? Absolute labor force growth (12-month change, s) 5,000 4,000 3,000 2,000 1, ,000-2, Source: IHS 2014 IHS 2014 IHS 8

economic growth Inadequate wages High incidence of parttime employment High long-term unemployment Structural Issues

9 US Outlook/ November 2014 Is the labor market tight or loose? This determination will drive the timing and magnitude of Fed actions Cyclical Issues (Loose) Resolved with improved economic growth Inadequate wages High incidence of parttime employment High long-term unemployment Structural Issues (Tight) Mismatches between labor supply and demand that will not change in the immediate future Aging labor force Skills gaps Poor mobility Lower participation rates 2014 IHS 9

10 US Outlook/ November 2014 There are two distinct problems with the labor force: its growth has slowed and fewer people are participating Employment and labor 160 Before the recession: 1.5 million / year pace After the recession: 0.35 million / year pace 68 Labor force (Millions) Percent of labor force percentage point = 1.6 million workers Source: IHS Labor force (Left) Participation rate (Right) 2014 IHS 2014 IHS 10

11 We re aging, and entering cohorts with lower participation rates US Outlook/ November 2014 Labor force size (millions) % 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Participation Rate (2013, % of labor force) Age cohort Particip. % 2014 IHS 11

12 Only the services areas are materially adding jobs Employment before and after the recession (millions) US Outlook/ November Goods Services Government Change during recession * Change since end of recession * *=Recession period: December 2007 through June 2009 Source: IHS Losses from recession: 7.4 million Changes since recession end: 8.7 million 2014 IHS 2014 IHS 12

13 US Outlook/ November 2014 Recent job creation is skewed toward the lower-income occupations Recent job growth and average weekly earnings Number of jobs (000s) Overall average weekly earnings $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $0 Average weekly earnings # of new jobs over past 12 months (bars, 000s, left axis) Average weekly earnings (squares, right axis) 2014 IHS 13

14 US Outlook/ November 2014 No discernible inflation pressures here Average hourly earnings (% change versus year-ago) Source: IHS Why are wages not rising? Sector mix new jobs created in lower-paying fields Experience displacement more experienced employees being replaced by less experienced ones Pent up wage deflation sticky wages prevented full wage adjustments from occurring during the recession 2014 IHS 2014 IHS 14

15 but maybe a little bit of new inflation here? It s probably too soon to say for sure Employment cost indexes (% change versus year-ago) US Outlook/ November Total Compensation Wages and Salaries Benefits 2014 IHS 15

16 US Outlook/ November 2014 Here s what the Fed is looking at to identify inflation Personal consumption price deflators (% change versus year-ago) Fed 2% threshold All goods and services Excluding food and energy Source: IHS 2014 IHS 2014 IHS 16

17 Monetary policy status quo maintained through mid-2015, although long-term rates will rise as expansion gathers steam Interest rate outlook (percent) 6 US Outlook/ November Fed tapering Near zero rates end June 2015 Source: IHS Fed funds rate 10-year treasury 2014 IHS 2014 IHS 17

US Outlook/ November 2014 The IHS federal funds forecast has lower rates for 2015-16 than the FOMC s dot plot results Target 2014 2015 2016 2017 Longer run 4.375, 4.500 * 4.125, 4.250 ** ** 3.875, 4.

18 US Outlook/ November 2014 The IHS federal funds forecast has lower rates for than the FOMC s dot plot results Target Longer run 4.375, * 4.125, ** ** 3.875, **** **** ***** 3.625, *** ****** 3.375, * ** *** 3.125, * *** * 2.875, * *** 2.625, * * 2.375, ** 2.125, ** 1.875, **** * 1.625, * * 1.375, *** 1.125, ** * 0.875, * *** 0.625, , * * 0.000, ******** ******** ** FOMC median (annual endpoint) IHS Forecast Number of FOMC participants 2014 IHS 18

19 US Outlook/ November 2014 Household formation 2014 IHS 19

20 US Outlook/ November 2014 Household formation has surprisingly downshifted Household formation q1-to-q1 change Why are households not forming? 1.5 Poor wage growth Slower immigration 1.0 Lower marriage rates 0.5 Limited access to credit Degraded mobility 0.0 Student loan burdens -0.5 Measurement issues IHS 20

21 Non-US citizen household formation is a significant contributor to the total Household formation q1-to-q1 change US Outlook/ November ,000,000 2,500,000 2,000,000 1,500,000 1,000, , , Total Non-US citizens 2014 IHS 21

22 US Outlook/ November 2014 Consumer, business and government spending 2014 IHS 22

23 Overall mortgage debt has come down, but financial obligations will increase as interest rates increase Debt and debt payments (share of disposable income, %) US Outlook/ November Outstanding Nonmortgage Consumer Debt Outstanding Mortgage Debt Monthly Financial Obligations* Interest payments, rent, auto lease payments, homeowners insurance and property tax Source: IHS 2014 IHS 2014 IHS 23

24 It s time to save for retirement US Outlook/ November 2014 Savings rate (share of disposable income, %) IHS 24

25 US Outlook/ November 2014 The federal budget deficit is now unproblematic Federal budget balance sheet (percent of GDP) 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% 2.8% of GDP Revenues Expenditures Deficit 2014 IHS 25

26 Productivity will increase in , but still remain sub-par Productivity growth (output / hour, year-over-year change) 5.0 US Outlook/ November What happened to productivity growth? Recent job growth skewed to services that are labor intensive General investment levels still low; long lags involved with technology investments Innovation and risk taking limited IHS 26

27 US Outlook/ November 2014 Energy 2014 IHS 27

28 Imports will supply only 12% of US energy requirements by 2024, down from 20% in 2014 US Energy Trade Balance US Outlook/ November 2014 Quadrillion BTUs Oil & Natural Gas Nuclear, Hydro & Other Energy Imports Energy Demand Source: IHS 2014 IHS 2014 IHS 28

29 Every $10/barrel decline in oil prices creates a $23bn gasoline dividend for consumers Cents / gallon Nominal consumer spending on gasoline ($ billions) Real consumer spending on gasoline ($ billions) US Outlook/ November IHS 29

30 US Outlook/ November 2014 Impact of a drop in oil prices from $112 / barrel in June to $83 today Adds 0.4% to real GDP over 2014 and 2015 Most from redeployed consumer spending, particularly to lower- and middle-income households Additional effects from improved consumer sentiment and reduced business costs Timing about evenly divided between 2014 and 2015 Includes offsetting impact of reduced drilling investment and increased imports Economic benefits not linear as additional declines in prices will trigger disproportionate production impact 2014 IHS 30

31 US Outlook/ November 2014 Contributions from unconventional energy sources will continue to add to US GDP US Imports of Petroleum Products (billions of 2009 dollars) US Mining and Petroleum Structures (billions of 2009 dollars) IHS 31

32 US Outlook/ November 2014 International Economic Growth and US Trade 2014 IHS 32

33 Stronger interest rates and relative economic growth point to an increase in the dollar Major trading partner exchange rate (inflation adjusted, 2009=1.0) US Outlook/ November Source: IHS 2014 IHS 2014 IHS 33

34 Modest increases in the trade deficit are expected beginning in the second half of 2015 Contribution to real GDP growth (percentage points) US Outlook/ November Exports Imports 2014 IHS 34

35 US Outlook/ November 2014 Economic growth will not be a factor to drive exports Country / Region Share of Exports Export growth (2014 vs thru Aug YTD) 2014/2013 q4/q4 real GDP growth 2015/2014 q4/q4 real GDP growth World 100.0% 3.2% 2.6% 3.3% Canada 19.2% 3.6% 2.3% 2.6% EU 17.3% 8.0% 0.8% 1.6% Mexico 14.8% 6.6% 3.6% 3.5% China 7.2% 6.2% 7.2% 7.1% Japan 4.2% 4.7% 1.1% 0.4% S. Korea 2.8% 10.6% 2.8% 3.8% Brazil 2.7% -3.4% -1.0% 3.1% Hong Kong 2.4% -7.1% 2.8% 3.3% Singapore 1.9% -0.6% 4.0% 3.8% Australia 1.7% 2.8% 2.5% 3.4% 2014 IHS 35

36 US Outlook/ November 2014 Several key US industries could be impacted if a steep economic downturn occurs in Europe Key merchandise exports to Europe ($bn) % change Aircraft and parts (civilian) Pharmaceutical preparations Medicinal equipment Passenger cars Fuel oil Chemicals - organic Industrial machines Chemicals - other Apparel, household goods non-textile IHS 36

37 Thank you! IHS Customer Care: Americas: IHS CARE ( ); Europe, Middle East, and Africa: +44 (0) ; Asia and the Pacific Rim: ; 2014 IHS. No portion of this report may be reproduced, reused, or otherwise distributed in any form without prior written consent, with the exception of any internal client distribution as may be permitted in the license agreement between client and IHS. Content reproduced or redistributed with IHS permission must display IHS legal notices and attributions of authorship. The information contained herein is from sources considered reliable but its accuracy and completeness are not warranted, nor are the opinions and analyses which are based upon it, and to the extent permitted by law, IHS shall not be liable for any errors or omissions or any loss, damage or expense incurred by reliance on information or any statement contained herein. For more information, please contact IHS at Customer Care (see phone numbers and addresses above). All products, company names or other marks appearing in this publication are the trademarks and property of IHS or their respective owners.

38 HOUSING OUTLOOK IHS David Crowe Chief Economist

39 Primary Points Recent activity Employment & housing First time buyers Forecasts

40 Recent Activity

41 Recent Housing Activity Housing starts 985 1,024 1, (000s) , , , (100) Jan Feb Mar Apr May Jun Jul Aug Sep Single-family Multifamily Source: Census

42 Recent Housing Activity Home sales 4,969 6,000 5,000 4,000 5,167 4,147 4,244 4,029 4,092 4,496 4,914 4,507 4,474 4,472 4,443 4,483 4,700 4,778 4,839 4,944 4,936 5,027 3,000 2,000 4,398 3,665 3,870 3,708 3,786 4,128 4,484 4,050 4,040 4,040 4,070 4,320 4,430 4,540 4,470 4,560 1, Jan Feb Mar Apr May Jun Jul Aug Sep New Single-family Existing Single-family Source: Census and NAR

43 New Homes Share of All Sales Average = 16% 9.2% 7.5% YTD Source: Census and NAR

44 Employment & Housing

45 Employment vs Single-family Permits % ND 20% Change in Employment 15% 10% 5% 0% -50% 0% 50% 100% 150% 200% 250% -5% Change in Single-family Permits

46 Unemployment Rates Falling, but young people are more likely to be unemployed than their older peers. 15% 15% years old 12% 9% 6% 10% 9% 8% years old All years old 11% 7% 6% 5% 3% 0% Q2.11 Q3.11 Q4.11 Q1.12 Q2.12 Q3.12 Q4.12 Q1.13 Q2.13 Q3.13 Q4.13 Q1.14 Q2.14

47 First Time Buyer

48 Trend in Home Sales Shrinking market especially new 6,500,000 6,247,978 5,500,000 5,265,441 5,517,492 5,324,690 4,500,000 4,214,734 4,081,213 3,500,000 3,253,301 2,500,000 1,500, , , st Time New 1st Time Existing Repeat New Repeat Existing Source: AHS

49 Shift in Total Home Sales New share went from 20% to 10% 1st Time New 6% 1st Time New Repeat 3% New 7% Repeat New 15% Repeat Existing 46% 47% Repeat Existing 54% 20% 1st Time Existing 36% 1st Time Existing 33% average 5.6 million sales/yr Source: AHS million sales

50 Homeownership Rates Falling for age groups but rising as households age Q Source: HVS

51 Real Income Changes by Age Group 15% 10% 11% 12% 5% 0% -5% -10% -15% -4% -8% 1% 1% -7% -9% 0% -11% 15 to 24 years 25 to 34 years 35 to 44 years 45 to 54 years 55 to 64 years 65 years and over % change: % change: % 4%

52 4. Head Winds Land Labor Capital Materials

53 Housing Starts (Area) and Low/Very Low Lot Supply (Bars) Starts (000s) Low Supply 60% 2,000 50% 1,500 1, % 30% 20% 10% 0 0%

54 Housing Starts (area) and % Reporting Labor Shortage Starts (000s) Shortage 2,000 60% 50% 1,500 40% 1,000 30% 20% % 0 0%

55 Share of Builders Who Lost Sale Because Buyer Could Not Qualify 60% 57% 50% 44% 40% 30% 20% 10% 0% Jan-13 Jan-14

56 Developers and Builders Seeking Credit Acquisition Development Construction

57 Builders Experiencing Price Increases in Last 6 Months Gypsum wall board Ready-Mix Cement Framing lumber Trusses Plywood OSB Windows & Doors Cabinets Roofing materials Millwork Insulation material Steel Beams HVAC eqpt Concrete brick&block Copper wiring Hardwood flrg Plumbing fixtures & fittings Vinyl siding Clay brick Steel (Lgtwgt) Ceramic Tiles SIPs 0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

58 Forecasts

59 Remodeling Market Index (RMI) At or above 50 for most of last two years

60 Residential Remodeling 180 Billions 2009 $, SAAR YR 4Q/4Q Chg % % % % % % Actual Adjusted

61 Multifamily Production Index 2+ years at or above NAHB MMI (L)

62 Multifamily Housing Starts Healthy Response from Growth in Renters Thousands Avg=339, ,000 Normal , ,000 39% ,000 25% ,000 15% ,000 0% ,000 2% 2016Q4: 109% % fall 2014Q3: 114% of Normal Trough to Current: 4 th Q 09 = 82,000 3 rd Q 14 = 378, %

63 80 NAHB/Wells Fargo Housing Market Index Builder sentiment recovers from recession s depth, recent winter HMI

64 2,000 1,800 1,600 1,400 1,200 Single-Family Starts Continuing to recover Thousands of units, SAAR ,343,000 Normal , ,000 24% ,000 16% ,000 2% ,000 26% ,101,000 37% 2016Q4: 90% 1, % fall 2014Q3: 48% of Normal Trough to Current: Mar 09 = 353,000 Sep 14 = 646, %

65 Questions? Answers: eyeonhousing.org

66 U.S. Manufacturing Outlook Presented by: Dan Meckstroth, Ph.D. Vice President and Chief Economist

67 Manufacturing Job Growth Slower, But Unemployment Is Lower Manufacturing Job Growth Percent Change in a 12-Month Moving Average(Year/Year) Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Unemployment Rate Percent Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Total Manufacturing Total Manufacturing Source(s): U.S. Bureau of Labor Statistics and MAPI

68 Manufacturing Capacity Utilization Close to Previous Peak Manufacturing Capacity Utilization 85 Capacity Utilization By Industry Percent Percent of Capacity Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Industry Sep Dec Peak to Aug. Manufacturing Motor vehicle, pts Food Plastics, rubber Communication eq Wood product Chemical Petroleum Machinery Paper Primary metal Electrical eq Fabricated metal Semiconductors Aerospace Source(s): Federal Reserve Board and MAPI

69 A Cyclical Recovery in Manufacturing Share of GDP; Number of Plants Starting to Level Out U.S. Manufacturing Plants and Share of Economic Output Thousands of Manufacturing Plants Percent of GDP Manufacturing's Share of GDP Number of Manufacturing Plants Source(s): U.S. Bureau of Economic Analysis and U.S. Bureau of Labor Statistics and MAPI

70 Corporations Have the Cash to Make Investments Non-Financial Corporate Profits Billions of Dollars Q Q Q Q Q Q Q Q Q Q Q Q Q Q3 Non-Manufacturing* Manufacturing* Income From Foreign Affiliates *Domestic profits only. Source(s): U.S. Bureau of Economic Analysis and MAPI

71 Consumers Spending Provides the Base, Acceleration From Investment and Materials Manufacturing Production by Demand Sector Percent Change Consumer-Driven Investment-Driven Material-Driven Source(s): MAPI

72 U.S. Manufacturing Is Recovered Manufacturing Industrial Production Index 2007= Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Total Manufacturing Non-High Tech Manufacturing Source(s): Federal Reserve Board and MAPI

73 Slow Business Productivity Growth, Manufacturing Somewhat Faster Productivity Growth Percent Change (Year/Year) Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q4 Manufacturing Non farm business Sector Source(s): U.S. Bureau of Labor Statistics

74 Trade Deficit in Goods More Negative Manufacturing Trade Deficit Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec Cumulative Billions of Dollars Source(s): U.S. International Trade Commission and MAPI

75 Porter Finds U.S. Very Competitive, Weaknesses Are Policy Driven United States National Competitiveness Factor Conditions Strengths: Workforce: very large, well-educated, skills-diverse. Finance Capital: high risk capital availability; highly-developed capital markets Infrastructure: extensive physical infrastructure systems including transport, water & sewer, energy, information & communications. Weaknesses: Infrastructure: aging systems losing reliability; D+ grade by ASCE Administration: highly-fractured governance; highly complex permitting and regulatory inconsistency Source(s): Michael Porter, Harvard Context for Strategy and Rivalry Strengths: Inter-firm competition: huge, highly-productive private sector; home to most MNCs; intense entrepreneurship culture; ranked 4 th by World Bank for Doing Business ; 7 th in GCI Openness: most sectors highly exposed to foreign competition; ranked 10 th in economic freedom IP Protection: highly-developed, well enforced IP institutions and laws Flexible labor markets: ranked 6 th in GCI Weaknesses: Taxation: comparatively high levels of corporate taxation Political Leadership: Partisan gridlock weakens economic policy development and coordination. Related and Supporting Industries Strengths: Clusters: multi-sector, multi-regional traded cluster development Innovation and R&D: high-levels of public and private R&D investment; high patent activity Export sector: suppliers compete globally Weaknesses: Focused on policy lobbying rather than industrial cooperation Demand Conditions Strengths: Market Size: world s largest consumer market; low savings rate; extensive commercial infrastructure; ranked 1 st in GCI Government Demand; high levels of government procurement activity Sophisticated demand: high quality, safety, and environmental standards; extensive consumer protections Weaknesses: GDP: long-term real GDP growth decline Consumer confidence: economic pessimism driving increase in savings

76 U.S. Operating Costs Fall Relative to Advanced Countries Manufacturing Unit Labor Costs in Selected Countries (percent change ) Australia Canada Italy France Netherlands Germany U.K. Japan U.S. Taiwan Source(s): The Conference Board

77 Economics Is Moving In Favor of U.S. Production Economic Reasons For More Local Sourcing Versus Offshoring o Value of the dollar-down 17% against broad currencies since 2002 o U.S. manufacturing unit labor costs fell over the last 10 years o Cost of shipping-air, truck, ocean long distances o Very low natural gas price in the U.S. o Rapid increase in labor costs in China (developing countries) o Customer demand for just-in-time delivery and collaboration o Natural disaster supply disruption-tsunami, earthquake, volcano, flood

78 The Other Costs of Offshoring Vendor Costs o The cost of adding a new supplier o The travel costs to visit suppliers or vice versa o Can low cost country suppliers keep you ahead of your competition o The difficulty in managing an extended supply chain o High turnover? The time/money training low cost country suppliers o Legal cost and intellectual property protection in low cost countries Usage Costs o Additional inventory in the supply chain o Quality or delivery issues could shutdown your plant o The cost of rework or warranty costs o Speed to market o R&D capabilities o Tooling Transaction Costs o Need for expediting o Freight cost, tariffs, insurance o Inspection costs

79 More Domestic Sourcing and/or Rising Export Share Is the Key to A Manufacturing Revival Manufacturing Import Share of Intermediate Purchases of Manufactured Goods 25 Percent That Are Imports Source(s): U.S. Bureau of Economic Analysis and MAPI

The US Economic Outlook

IHS ECONOMICS US Outlook The US Economic Outlook November 2014 ihs.com Rafael Amiel, Director latin America Economics +1 215 789 7405, rafael.amiel.ihs.com 2014 IHS The US economy is gaining momentum Growth