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Trans-Atlantic Market Relationships

Comments To

Global Interdependence CenterGIC Abroad - Paris

Investment SeminarJ. Paul Horne

Independent Market EconomistParis – 8 Dec. 2006

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U.S. – Europe Correlations• $ and € financial markets convergent• GDP growth trends – to converge ?• Productivity trend: US ▼ Euro ▲ • Inflation or ... disinflation ?• Interest rates – convergence ahead• FX – symptom of basic disequilibria• Equities in ’07: post-2002/3 bull tired

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Equity market trends – 1994 - 2006

• Source: ECB Nov. Mthly. Bull. – mthly. Avgs.

Post-2000 lows

US lost lead

Think Tokyo dull ?

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Equity markets since 2002/3 lows

• Source: MSCI, Bloomberg, Horne Economics – thru 2dec06

Tokyo top gainer since 2003

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Intl. P/Es & volatility – 1988-2006

• Source: BIS Annual Report, Jun06

Convergence startling !

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Equity & debt home bias (%)

• Source: ECB November Monthly Bulletin.

Decline = int’l. diversification.

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GDP growth rates since 1999

• Source: ECB Nov. Monthly Bulletin – % a.r., qrtly.

EU Potential GDP: 2%+

US potential GDP: 3%

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Euro-U.S. Corporate Profits Growth Trends

• Source: ECB Monthly Bulletin, Sep06. 12 & 60-mo. forecasts Euro STOXX & SPX.

Long trend attracts capital to US;financing C/A; boosting our debt.

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OECD: synchronization in Sep06

• Source: OECD, Composite Leading Indicators, Nov06

US declined since Sep.

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Productivity growth trends since 1992

50

70

90

110

130

150

170

1992

= 1

00

UK Germany France US Sweden

19921992-2005 avg

• Sources: ECB, Eurostat, BLS – 2dec06.

2005 avg.

141157

176 195

235

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CPI trends 1999 - 2006

• Source: ECB Nov. Mthly. Bull. - % a.r., mthly.

€ = 1.8% Nov06

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Households net lending – 1997 - 2004

• Source: ECB Nov. Mthly. Bull. - % of GDP.

EU, JP, CH finance US over-spending

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ECB – Fed monetary policy 1999 - 2006

• Source: ECB November Monthly Bulletin. Official rate changes.

ECB to hike 25-50 bps

Fed succeeded.Next move down.

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3-mo. Money market rates – 1994 -2006

• Source: ECB Nov. Mthly. Bull. – a.r., mthly.

Convergence will increase

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10-yr. Govt. bond yields – 1994 - 2006

• Source: ECB Nov. Mthly. Bull. – Mthly. Avgs.

In parallel how long ?

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Key FX rates – before $ plunge

• Source: ECB Nov. Monthly Bulletin – 1Q99 = 100.

$1.333:€1 on 3dec06

$ hi: $0.823

$ lo: $1.365on 30dec04

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December 2005 Forecasts ...• “... I serve up the following forecasts for 2006:

$1.35 per euro and U.S. ten-year T-yields up to 5%, both by end-2006; stagnation of the U.S. housing market slows GDP growth to 2.5% by 4Q06; the S&P 500 drops 10 % in the year; oil and gold remain around today’s prices; and Europe’s economy sticks at 2.0%. U.S. Mid-term elections will cost the administration seats but, unfortunately, not control of House and Senate.”

• Source: J.P. Horne Yearend letter, Dec. 2005

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Conclusions - 2007 Forecasts

• US – Euro GDP growth to converge ▼• Inflation may slow ▼ = disinflation• $ and € bond yields in parallel ▼• Euro equities to outperform – then ▼• Fed and ECB rates will converge - ▼• $ ▼ to $1.40/3 : € by Jun07; then ▲• Beware of financial black holes ....