ECONOMIC OUTLOOK, 2010 HEALTH CARE FORECAST CONFERENCE, UNIVERSITY OF CALIFORNIA, IRVINE, CA, FEBRUARY 25, 2010 JAMES GLASSMAN ([email protected],

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JAMES GLASSMAN ([email protected], o212–270–0778, o212-834-5093, m609-510-3723 )

“I gotta feeling …”

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A good, good day …

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We began to recover early last summer …US real GDP (annualized percent change from the previous quarter)

Source: US Department of Commerce

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

8

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

8

Forecast

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… most didReal GDP in selected regions (percent change from four quarters earlier)

Sources: US Department of Commerce; JPMorgan Chase & Co.

-10-9-8-7-6-5-4-3-2-10123456789

10

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012-10-9-8-7-6-5-4-3-2-1012345678910

US (blue-gray, dashed line is forecast)EU-11 (black)Japan (red)

Emerging economies in Asia, Eastern Europe and Latin America (orange)

Global (blue-shaded region)

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There’s nothing “new normal” about today’s economic stateUS real GDP (percent change from four quarters earlier)

Sources: NBER recession bars; US Department of Commerce; various academic sources

-15

-10

-5

0

5

10

15

20

1852 1862 1872 1882 1892 1902 1912 1922 1932 1942 1952 1962 1972 1982 1992 2002-15

-10

-5

0

5

10

15

20

Average historical growth = 3.75% annually

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The nightmare is coming to an end … sooner for someUnemployment along the Pacific Coast (percent)

Source: US Department of Labor

4

5

6

7

8

9

10

11

12

13

1975 1980 1985 1990 1995 2000 2005 20104

5

6

7

8

9

10

11

12

13Lines:CaliforniaOregon (dashed red line)Washington

Shaded area:US (shaded region)

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Why recovery signs are for real

The financial panic has passed (things are back to normal in the Fed’s back yard)

Self-correcting adjustments (inflated house prices are a thing of the past and most business are sitting pretty for once)

Policy help will be there for as long as is needed (0% policy rate, Fed asset purchases and “political will”, fiscal stimulus)

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0


0

1

2

3

4

5

6

2007 2008 2009 20100

1

2

3

4

5

6

3-month dollar-based Libor

3-month overnight indexed swap rate (OIS)

The panic that invaded the Fed’s back yard is goneSelected rates in the interbank term funding markets (percent)

Sources: BBA; Federal Reserve Board

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The weakest links are welcomed with open arms againLong-term yield on noninvestment grade debt less 10-year Treasury yield (basis points)

Sources: JPMorgan Chase & Co.; Bloomberg

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

Ibbotson Associates JPMorgan Securities Inc.

CDX.HY

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Houses are affordable once again …Nominal gross income per household and house prices (ratio to 1970 Q1 level)

Sources: Loan Performance Corporation; US Department of Commerce

0

1

2

3

4

5

6

7

8

9

10

11

12

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 100

1

2

3

4

5

6

7

8

9

10

11

12Loan Performance Corporation

Gross nominal income per household

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Businesses are profitable again …After-tax GDP profits (percent of nominal Gross Domestic Income)


0

1

2

3

4

5

6

7

8

9

10

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 20070

1

2

3

4

5

6

7

8

9

10

After-tax GDP profits from current production

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Cap X spending has a pulse …Business investment for capital goods and software (percent change from a year earlier)

Sources: US Department of Commerce; Federal Reserve Board

-25

-20

-15

-10

-5

0

5

10

15

20

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-25

-20

-15

-10

-5

0

5

10

15

20Shaded area denotes real business spending for equipment & software

Industrial output of business equipmentOrders for capital goods excluding civilian aircraft and defenseNonauto capital goods importsShipments of nondefense capital goods

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So, where are the jobs? Four realities …

GDP surging

Payrolls are still shrinking (survey of businesses, including guesses about small businesses)

Unemployment is falling, employment’s rising (survey of households)

Layoffs are tumbling (unemployment insurance)

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… three (GDP, household surveys, and jobless claims) …Real GDP (chained 2005 dollars) Employment (thousands)

Sources: US Department of Labor; US Department of Commerce

10,000

10,500

11,000

11,500

12,000

12,500

13,000

13,500

2000 2002 2004 2006 2008 2010126,000

128,000

130,000

132,000

134,000

136,000

138,000

140,000

GDP (left)

Employment, payroll concept based on the Household Survey (right)Nonfarm payrolls (right)

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… harmonizeReal GDP (% ch from four quarters earlier) Initial claims for unemployment benefits (thousands weekly)

Sources: US Department of Labor; US Department of Commerce

-4

-3

-2

-1

0

1

2

3

4

5

6

7

8

9

1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

50

100

150

200

250

300

350

400

450

500

550

600

650

700

Real GDP growth (left)

Jobless claims (right, scale is reversed)

Forecast

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Inflation … R.I.P.

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“Low levels of resource utilization”, the big ideaUS unemployment rate (percent of the labor force)

¹ Range of FOMC members’ viewsSources: NBER recession bars; US Department of Labor; Federal Reserve Board

0

1

2

3

4

5

6

7

8

9

10

11

12

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 20150

1

2

3

4

5

6

7

8

9

10

11

12

The Fed's view about the near-term and sustainable (Nairu) unemployment level¹

Note: thin line represents forecast

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Unemployment … what you don’t see counts tooRatio of selected worker status to the population

Source: US Department of Labor

0.50

0.52

0.54

0.56

0.58

0.60

0.62

0.64

0.66

0.68

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 20080.50

0.52

0.54

0.56

0.58

0.60

0.62

0.64

0.66

0.68

Working part time because can't find full time work

Actively looking for a job and unemployed

Working full time or by choice, if part time

Gave up and dropped out

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Remember how recessions work on inflation … slowlyCore chain PCE inflation (annualized percent change)


0

1

2

3

4

5

6

7

8

9

10

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 20100

1

2

3

4

5

6

7

8

9

10% change from 12 months earlier% change at an annual rate from six months earlier

when the recessions are believed to have ended

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The textbook story (about the Weimar Republic) …Federal Reserve assets (billions of dollars outstanding)

Source: Federal Reserve Board

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500

Aug 2007 Dec 2007 Apr 2008 Aug 2008 Dec 2008 Apr 2009 Aug 2009 Dec 2009

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500

Fed loans

MBS holdings

GSE holdings

Treasuries

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… doesn’t apply …Federal Reserve liabilities (billions of dollars outstanding)


0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500

Aug 2007 Dec 2007 Apr 2008 Aug 2008 Dec 2008 Apr 2009 Aug 2009 Dec 2009

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500 Deposits at the Fed other than those ofdepository institutions, including theTreasury's supplementary financingaccountReverse RPs, Treasury cash, and otherliabilities and capital

Excess reserves

Required reserves (includes vault cashused to satisfy reserve requirements)

Currency in circulation excluding surplusvault cash held by depository institutions

All factors absorbing reserves

monetary base

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… because the Fed’s reserves remain it its vaultsMonetary base (billions of dollars) M2 (billions of dollars)


0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

1970 1975 1980 1985 1990 1995 2000 2005 20100

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

22,000

Monetary base (left scale)M2 (right scale)

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Assault on America’s living standard? …

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They say median family income has stalled …Real median family income (chained 2005 dollars)


0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 20070

10,000

20,000

30,000

40,000

50,000

60,000

70,000

25

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… that workers are more expendable …Unemployment rate change (pct points) Real GDP (percent change from 12 months earlier)


-4

-3

-2

-1

0

1

2

3

41947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007

-9

-6

-3

0

3

6

9

12

15Change (percentage points) in the unemployment rate over the past 12 months (solid area)

Percent change in real GDP over the past 12 months (line)

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… not getting their fair shareLabor productivity in the nonfarm business sector and private hourly compensation (1985 = 1.0)


0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 20070.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Labor productivity

Real private sector hourly compensation

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The world’s transforming (be a shareholder for now)After-tax adjusted* business profits (percent of nominal GDP)

* GDP basis—that is, capital consumption allowances and differences in inventory valuationSource: US Department of Commerce

0

1

2

3

4

5

6

7

8

9

10

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 20070

1

2

3

4

5

6

7

8

9

10

28

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Conclusion … use your imagination

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Wall Street (where we discount eternity) does …Market value of all publicly traded stocks (Wilshire 5000 index)

Source: Dow Jones

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 100

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

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… because it’s the possible that countsUS real GDP (chained 2000 dollars)

Sources: US Department of Commerce; Macroeconomic Advisers LLC

7,000

8,000

9,000

10,000

11,000

12,000

13,000

14,000

15,000

16,000

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 127,000

8,000

9,000

10,000

11,000

12,000

13,000

14,000

15,000

16,000Estimated potential level of real GDP (GDP level when

unemployment is 5%

If the economy

grows 4.4%, 2.4%, and

3.7% in 2010, 2011, and

2012, respectively, and 4% after

that

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Appendix 1. Fiscal foxes and red herrings

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Wanted … a new conversation about fiscal issues

The airwaves are full of nonsense (like global warming, it’s not about the seasonal shifts)

Tedious … we don’t need you to repeat the front pages

Pointless … we’re not going to cut the deficit in recession

Misdirected focus … the $1.5 trillion – $1 trillion due to recession – isn’t the issue

It’s the underlying (long-term) issue

Left on auto pilot, spending doubles as a share of the economy (CBO)

Five options:

(1) Double the tax burden … not happening

(2) Deficit finance … over the market’s (and economy’s) dead body

(3) Defer to an outsider (the government) to continually whittle health care spending

(4) Incentivize the industry to find the best solution … users need to be more involved

(5) Change the conversation about economics (raise economic literacy):

* Endogenize the retirement decision

* Spur national saving (eliminate the tax on saving, consumption-based income tax)

* Eliminate the corporate income tax (people pay taxes)

* Eliminate the employer deductibility of health care expenses

* Tort reform

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Bonds to pundits: it’s not about today’s red ink …Federal budget balance (percent of GDP) 10-year Treasury yield (percent)

Sources: NBER recession bars; Congressional Budget Office; Federal Reserve Board

-11-10-9-8-7-6-5-4-3-2-101234

1960 1970 1980 1990 2000 2010012345678910111213141516

Actual federal budget balance (% of GDP) on the left scale10-year Treasury yield on the right scale

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FEB

RUAR

Y 25

, 201

0


The red ink, scary of course, in absolute terms …Federal budget balance (billions of dollars over the most recent 12 months)

Sources: NBER recession bars; NBER Macroeconomic database

-1,600

-1,400

-1,200

-1,000

-800

-600

-400

-200

0

200

400

1879 1889 1899 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999 2009-1,600

-1,400

-1,200

-1,000

-800

-600

-400

-200

0

200

400

35

ECO

NOM

IC O

UTLO

OK,

201

0 HE

ALTH

CAR

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RECA

ST C

ONF

EREN

CE, U

NIVE

RSIT

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F CA

LIFO

RNIA

, IRV

INE,

CA,

FEB

RUAR

Y 25

, 201

0


Scaled to the economy, recessions do a number on budgetsFederal budget balance (percent of GDP)

Sources: NBER recession bars; NBER Macroeconomic database

-0.30

-0.25

-0.20

-0.15

-0.10

-0.05

0.00

0.05

1879 1889 1899 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999 2009-0.30

-0.25

-0.20

-0.15

-0.10

-0.05

0.00

0.05

36

ECO

NOM

IC O

UTLO

OK,

201

0 HE

ALTH

CAR

E FO

RECA

ST C

ONF

EREN

CE, U

NIVE

RSIT

Y O

F CA

LIFO

RNIA

, IRV

INE,

CA,

FEB

RUAR

Y 25

, 201

0


… here’s how much …Actual budget balance and excluding the impact of the recession (percent of GDP)

Sources: NBER recession bars; Congressional Budget Office; JPMorgan Chase & Co.

-11-10-9-8-7-6-5-4-3-2-101234

1960 1970 1980 1990 2000 2010-11-10-9-8-7-6-5-4-3-2-101234

Actual federal deficit (% of potential GDP)Cyclically-adjusted federal deficit (% of potential GDP)

37

ECO

NOM

IC O

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Y 25

, 201

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… or, if you want the numbersCyclical (temporary) factors boosting the federal deficit (billions of dollars, fiscal year basis)

Sources: Congressional Budget Office; JPMorgan Chase & Co.

2007 2008 2009 2010 2011 2012 2013

Latest estimate of the fiscal budget (January 2010) -161 -459 -1,414 -1,349 -980 -650 -539

% of GDP -1.2% -3.2% -9.9% -9.2% -6.5% -4.1% -3.2%

Three cy clical (temporary ) factors boosting the deficit (cost in billions of dollars):

Financial rescues 0 0 424 106 36 26 17

GSE rescue 0 0 291 26 21 16 14TARP 0 0 133 80 15 10 3

Fiscal initiativ es 0 158 246 399 139 40 28

Fiscal stimulus (Economic Stimulus Act of 2008) 158 46 -5 -11 -10 -7Fiscal stimulus (ARRA of 2009) 200 404 150 50 35

Recession impact on the budget 69 113 335 446 427 407 387

CBO's estimate of the cy clical contribution 29 73 295 406 387 367 347Adjustment assuming 4.5% unemploy ment 40 40 40 40 40 40 40

Excluding the cyclical/financial rescue costs -132 -228 -449 -438 -418 -217 -147

% of GDP -0.9% -1.6% -3.2% -3.0% -2.8% -1.4% -0.9%

Memoranda:Nominal GDP 13896.1 14439.1 14236 14595 14992 15730 16676Debt held by the public 5035 5803 7,544 8,893 9,873 10,523 11,062

% of GDP 36.2% 40.2% 53.0% 60.9% 65.9% 66.9% 66.3%

38

ECO

NOM

IC O

UTLO

OK,

201

0 HE

ALTH

CAR

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RECA

ST C

ONF

EREN

CE, U

NIVE

RSIT

Y O

F CA

LIFO

RNIA

, IRV

INE,

CA,

FEB

RUAR

Y 25

, 201

0


CBO gives you the starting point …CBO’s government spending projections (billions of dollars, fiscal year basis)

Source: Congressional Budget Office

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 20800

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

Debt service

Other

Medicare and Medicaid

Social Security

39

ECO

NOM

IC O

UTLO

OK,

201

0 HE

ALTH

CAR

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RECA

ST C

ONF

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CE, U

NIVE

RSIT

Y O

F CA

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RNIA

, IRV

INE,

CA,

FEB

RUAR

Y 25

, 201

0


… and they say spending will outstrip revenues*Long-term projections (billions of dollars, fiscal year basis)


0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 20800

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

Debt service

Other


Social Security

Revenues (historical average of 18.1% of GDP

and assuming CBO's GDP assumption)

40

ECO

NOM

IC O

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OK,

201

0 HE

ALTH

CAR

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RECA

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CE, U

NIVE

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Y O

F CA

LIFO

RNIA

, IRV

INE,

CA,

FEB

RUAR

Y 25

, 201

0


The electorate won’t accept (1) a doubled tax burden …Long-term projections (percent of GDP)


0

5

10

15

20

25

30

35

40

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 20800

5

10

15

20

25

30

35

40

Debt service

Other


Social Security

Revenues (historical average of 18.1%)

41

ECO

NOM

IC O

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201

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CAR

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RNIA

, IRV

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CA,

FEB

RUAR

Y 25

, 201

0


The bond market won’t accept (2) a mounting debt service …Long-term projections (billions of dollars, fiscal year basis)


0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 20800

20,000

40,000

60,000

80,000

100,000

120,000

140,000

Debt service

Other


Social Security

Revenues (historical average of 18.1% of GDP

and assuming CBO's 2.2% long-run GDP growth

assumption)

42

ECO

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201

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CA,

FEB

RUAR

Y 25

, 201

0


The (3.5%) growth* option …Long-term projections (billions of dollars, fiscal year basis)


0

10,000

20,00030,000

40,000

50,000

60,00070,000

80,000

90,000

100,000

110,000120,000

130,000

140,000

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 20800

10,000

20,00030,000

40,000

50,000

60,00070,000

80,000

90,000

100,000

110,000120,000

130,000

140,000Revenues (if the economy grows 3.5%, just below the 3.75% historical average)

Debt service

Other


Social Security

43

ECO

NOM

IC O

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201

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CAR

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CA,

FEB

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Y 25

, 201

0


… keeps the spending share in line with revenuesLong-term projections (billions of dollars, fiscal year basis)


0

5

10

15

20

25

30

35

40

1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 20800

5

10

15

20

25

30

35

40

Revenues

Debt service

Other

Medicare and MedicaidSocial Security

44

ECO

NOM

IC O

UTLO

OK,

201

0 HE

ALTH

CAR

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RECA

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CA,

FEB

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Y 25

, 201

0


The growth* option … why it’s an issueLong-term projections (billions of dollars, fiscal year basis)


-15

-10

-5

0

5

10

15

20

1851 1876 1901 1926 1951 1976 2001 2026 2051 2076-15

-10

-5

0

5

10

15

20

Average historical growth = 3.75% annually

CBO assumption

45

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, 201

0


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General: Information has been obtained from sources believed to be reliable but JPMorgan does not warrant its completeness or accuracy except with respect to any disclosures relative to JPMSI and/or its affiliates and the analyst’s involvement with the issuer. Opinions and estimates constitute our judgment as at the date of this material and are subject to change without notice. Past performance is not indicative of future results. The investments and strategies discussed here may not be suitable for all investors; if you have any doubts you should consult your investment advisor. The investments discussed may fluctuate in price or value. Changes in rates of exchange may have an adverse effect on the value of investments. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. JPMorgan and/or its affiliates and employees may act as placement agent, advisor or lender with respect to securities or issuers referenced in this report. Clients should contact analysts at and execute transactions through a JPMorgan entity in their home jurisdiction unless governing law permits otherwise. This report should not be distributed to others or replicated in any form without prior consent of JPMorgan. U.K. and European Economic Area (EEA): Investment research issued by JPMSL has been prepared in accordance with JPMSL’s Policies for Managing Conflicts of Interest in Connection with Investment Research. This report has been issued in the U.K. only to persons of a kind described in Article 19 (5), 38, 47 and 49 of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2001 (all such persons being referred to as “relevant persons”). This document must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. In other EEA countries, the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction. Australia: This material is issued and distributed by JPMSAL in Australia to “wholesale clients” only. JPMSAL does not issue or distribute this material to “retail clients.” The recipient of this material must not distribute it to any third party or outside Australia without the prior written consent of JPMSAL. For the purposes of this paragraph the terms “wholesale client” and “retail client” have the meanings given to them in section 761G of the Corporations Act 2001. Korea: This report may have been edited or contributed to from time to time by affiliates of J.P. Morgan Securities (Far East) Ltd, Seoul branch.

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Documents

ECONOMIC OUTLOOK, 2010 HEALTH CARE FORECAST CONFERENCE, UNIVERSITY OF CALIFORNIA, IRVINE, CA, FEBRUARY 25, 2010 JAMES GLASSMAN ([email protected],