Robert Johnson, CFA

Director of Economic Analysis

Morningstar

U.S. Economy a

Rocket Ship on the

Pad or an Ocean

Liner?

22Source: University of Michigan, Low-Tech Magazine

U.S. Economy a Rocket Ship on the Pad or an Ocean Liner?

3

U.S. Economy 2013, The Year of the Ocean Liner

2013 Review: Another Year of Slow but Steady Growth

• Real U.S. GDP Grew 1.9%

• Inflation Fell to 1.5% as Commodities Remained Under Control

• Employment Growth Ticked up to 193,000 Per Month

• Unemployment Rate Dropped to 6.7%

• Ten-Year Treasury 2.9% at Year-End

Source: BEA, Updated April 30, 2014, Morningstar Inc.

Quarter Quarter One Year Ago

Quarter-over-

Quarter Year-over-Year

Q1 2012 3.3 3.7

Q2 2012 2.8 1.2

Q3 2012 3.1 2.8

Q4 2012 2.0 0.1 2.8

Q1 2013 1.3 1.1

Q2 2013 1.6 2.5

Q3 2013 2.0 4.1

Q4 2013 2.6 2.6 1.9

Q1 2014 2.3 0.1

Where Is the Economy Now? It Depends.

5Source: Bureau of Economic Analysis, May 1, 2014

-2%

0%

2%

4%

6%

2010 2011 2012 2013 2014

Real Disposable Personal Income, Consumption, and Wage, Year-over-Year Growth

Real disposable personal income

Consumption

Wages

Consumption Remains Slow, But Stable as Income Fluctuates

6Source: U.S. Bureau of Labor Statistics, Updated May 2, 2014

-2%

-1%

0%

1%

2%

3%

2010 2011 2012 2013

Employment Growth Since 2010

Private Sector

Total Nonfarm

Private Sector Employment Continues to Grow

U.S. Economic Forecast

The Outlook for 2014

• Real U.S. GDP Growth of 2.0%-2.5%

• Inflation 1.5%-1.8%

• Employment Growth Steady at 190,000 Per Month

• Unemployment Rate Drops to 5.9%-6.2%

• Ten-Year Treasury Increases to 3.5-4.0%

• Home Prices Increase 5.0%

Source: BEA, Updated April 30, 2014, Morningstar Inc.

Annualized Year-over-Year Annual (Full Year)

Quarter GDP Growth Rate GDP Growth Rate GDP Growth Rate

Q1 2013 1.1% 1.3%

Q2 2013 2.5% 1.6%

Q3 2013 4.1% 2.0%

Q4 2013 2.6% 2.6% 1.9%

Q1 2014E 0.1% 2.3%

Q2 2014E 2.6% 1.4%

Q3 2014E 2.3% 1.8%

Q4 2014E 2.3% 2.2% 2.2%

More Slow Growth Ahead

Economic Drivers

• Consumer Spending Up More Than 2%

• Less Fiscal Drag, Government Spending Stabilizes

• Housing and Autos Grow, but Slowly

• World Economy Picks Up Steam

99

Worries

10Source: The Nation, Children’s Healthcare Knowledge Repository, CBS Sacramento, SodaHead, Accendo Markets, AIMS.org, AP/Canadian Press

Reasons For Optimism

Source: Soul Seeds

Residential Spending Has Huge Upside Potential

12

0%

2%

4%

6%

8%

10%

1947 1954 1961 1968 1975 1982 1989 1996 2003 2010

Residential Spending as a Percentage of GDP

Average

Source: Bureau of Economic Analysis, Updated April 30, 2014

Source: Energy Information Administration, Morningstar Estimates

-15%

-8%

-1%

6%

13%

20%

0.0

2.0

4.0

6.0

8.0

10.0

1995 2000 2005 2010 2015 2020

Mill

ions o

f barr

els

/day

U.S. Oil Production

Year-over-YearGrowth

2014 forecast

Year-over-Year

U.S. Oil Production Skyrockets

Source: IMF, Updated April 8, 2014

IMF Full-Year Real GDP Growth

Rates

% Change

2012 2013 2014F 2015F

Euro area -0.7 -0.5 1.2 1.5

Japan 1.4 1.5 1.4 1.0

Australia 3.6 2.4 2.8 2.7

Brazil 1.0 2.3 2.8 2.7

Russia 3.4 1.3 1.3 2.3

India 4.7 4.4 5.4 6.4

China 7.7 7.7 7.5 7.3

Canada 1.7 2.0 2.3 2.4

United States 2.8 1.9 2.8 3.0

Advanced 1.4 1.3 2.2 2.3

Emerging 5.1 4.7 4.9 5.3

World 3.2 3.0 3.6 3.9

World Growth Is Showing Signs of Life

Source: U.S. Bureau of Labor Statistics, Updated April 15, 2014

-4%

0%

4%

8%

12%

16%

1955 1961 1967 1973 1979 1985 1991 1997 2003 2009

Consumer Price Index, Year-over-Year Change Shaded areas represent recessions

Inflation Remains Low, More Money in Consumers’ Pockets

16Source: St. Louis Federal Reserve, Congressional Budget Office

10,000

12,000

14,000

16,000

18,000

20,000

22,000

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024

Potential versus Actual GDP

GD

P B

illio

ns

Shaded areas represent CBO

forecast

Output Potential Gap Suggests Limited Inflation Risk

17

Source: Actuals and Estimates From IMF, April 8, 2014

Commodity Prices

Annual Price Changes in U.S. $

Non-Oil

Commodities (%) Oil (%)

2012 –10.0 1.0

2013 –1.2 –0.9

2014F –3.5 0.1

2015F –3.9 -6.0

The IMF Projects Even More Declines

Source: Morningstar Direct, Updated May 5, 2014

6.2%

-39.6%

32.2%

13.8%

2.20%

14.1%

34.1%

2.8%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

2007 2008 2009 2010 2011 2012 2013 2014 YTD

S&P 500 Annual Return Since 2007

Part of Stock Market Gains Will Be Spent, Eventually

19Source: Morningstar Direct, Updated May 5, 2014

-60%

-40%

-20%

0%

20%

40%

60%

80%

2006 2007 2008 2009 2010 2011 2012 2013

S&P 500 Total Return Since October 2006

Market 207%

Stock Market Gains Add Up

Source: St. Louis Federal Reserve, S&P/Case-Shiller, Updated April 29, 2014

100

120

140

160

180

200

220

2000 2002 2004 2006 2008 2010 2012 2014

S&P/Case-Shiller 20 City Price Index

Home Prices Up, Encouraging Consumers

Source: Snail-World.com

Some Growth Categories Are Slowing

Source: Bureau of Economic Analysis, Morningstar, Inc.

4

6

8

10

12

14

16

18

20

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Annual Light Vehicle Retail Sales

Year-over-Year Growth Millions of Units

2014E

Auto Sales Growing, but at a Slowing Pace

Source: Census Bureau, National Association of Realtors

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Existing Home Sales and Housing StartsYear-over-Year Growth

Existing Home Sales

Housing Starts

2014E

Existing Home Sales Lucky to Grow, Home Starts Growth Shrinks

Source: FannieMae, Credit Characteristics of Single-Family Business Acquisitions

700

710

720

730

740

750

760

770

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Average FICO Credit Score

1.40% 3.40%

9.70%

18.20%

67.30%

Score Distribution, 2013

0-620

620-660

660-700

700-740

740+

Tight Lending Standards Continue to Hold Back Housing

Source: The Federal Reserve

0

1

2

3

4

5

6

7

1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Charge-Offs and Delinquency Rates on Loans at Commercial Banks

Consumer Loans

Business LoansD

elin

qe

ncy R

ate

Loan Delinquency Rates Hit Pre-Recession Lows

Source: The Federal Reserve

0

2

4

6

8

10

12

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Charge-Offs and Delinquency Rates on Real Estate at Commercial Banks

Residential Single-FamilyMortgages

De

linq

ency R

ate

But Mortgage Struggles Continue

Source: International Council of Shopping Centers

0

1

2

3

4

5

2010 2011 2012 2013 2014

Shopping Center Same Store Sales, Year-over-Year Growth, 5-Week Average

Perc

enta

ge

Shopping Center Sales under Pressure

Source: Census Bureau

-6%

-4%

-2%

0%

2%

4%

6%

8%

2009 2010 2011 2012 2013

Retail Sales Ex-Auto and Gas, Year-Over-Year Change, 3-Month Average

Inflation-Adjusted

Nominal

Retail Sales Edge Lower

Source: St. Louis Federal Reserve, S&P/Case-Shiller, Updated April 29, 2014

-8%

-4%

0%

4%

8%

12%

16%

2010 2011 2012 2013 2014

Case-Shiller Home Price Index Annual Change, 3-Month Average

Home Prices Up But Plateauing

Source: Morningstar, Inc.

0

2

4

6

8

10

12

14

2010 2011 2012 2013 2014 2015 2016 2017

Boeing Build Rates per YearMorningstar Forecast

Boeing 787 Production Capability Topping Out

Source: Morningstar Direct, Updated May 5, 2014

-5%

0%

5%

10%

15%

20%

25%

30%

35%

2010 2011 2012 2013

PowerShares DB Commodity Index (DBC)

Weak Commodity Prices Could Limit World Growth

Source: St. Louis Federal Reserve, Updated April 15, 2014

-4

-3

-2

-1

0

1

2

3

4

5

6

1988 1992 1996 2000 2004 2008 2012

10-Year Treasury and CPI Inflation Spread

Perc

enta

ge

Rate

Average Equals 2.5%

Inflation Rate and Typical Spread Suggest Higher Interest Rates Ahead

Long Term Worries

Source: Babypips.com

Source: Bureau of Economic Analysis, Census Bureau

0

0.01

0.02

0.03

0.04

0.05

0.06

0.8%

1.0%

1.2%

1.4%

1.6%

1.8%

2.0%

1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 2013

Population Growth versus Real GDP Growth, Trailing 5-Year Averages

Population Growth (Lagged 5 Years) Real GDP Growth

Population Growth Real GDP Growth

Slowing Population Growth Means Diminished GDP Prospects

Source: Census Bureau, Updated May 2013

0%

4%

8%

12%

16%

20%

2020 2025 2030 2035 2040 2045 2050 2055 2060

Projected Population Growth Rates

Under 18 years

18 to 64 years

65 years and over

Older Consumers Who Spend Less Growing the Fastest

3636Source: ThinkAdvisor.com, Census Bureau

More Baby Boomers to Retire in Near FuturePercentage of Population over the Age of 65

Source: Bureau of Economic Analysis, Morningstar Calculations

0.2

0.4

0.6

0.8

1.0

2005 2007 2009 2011 2013

Key Auto Statistics, Ratio Based on 2005 High, 3-Month Moving Average

Sales Employment Production

Auto Sales Back to Normal, Employment not so Much

38Source: Congressional Budget Office

-12

-10

-8

-6

-4

-2

0

2

4

1950 1956 1962 1968 1974 1980 1986 1992 1998 2004 2010 2016 2022

Budget Deficit as a Percentage of GDP Shaded area represents CBO forecast

Budget Problems Reappear as Baby Boomers Retire

Source: Brain Wyzard

E-Shopping Means Fewer Stores and Retail Employees

Source: Census Bureau, International Council of Shopping Centers

Weekly Shopping Center Sales Fall as E-Commerce Grows

Source: Nature Jobs

Working Remotely Means Less Need for Office Space

Conclusion: Muddle Through, Again

Source: Virtual Media