ECONOMICS

6 August 2004
David A. Rosenberg
First Vice President
The Market Economist
Chief North American Economist
(1) 212 449-4937 Weekly Guidebook for the Global Investor

United States

Highlights of This Issue

Contributors View From the Desk: Fed To Stay The ‘Measured’ Course 2
Kathleen Bostjancic Today’s weak July employment figures along with our GDP and inflation
Director, Senior Economist forecasts for 2004 and 2005 strongly suggest that the Fed funds rate will
(1) 212 449-2650
Kathy_Bostjancic@ml.com
peak no higher than 2.5% by the end of Q1 2005. Bond yields are likely to
discount this ahead of time.
Jose A. Rasco
VP, Senior Economist Hot Topic: Housing: If Not a Bubble Then an Oversized Sud 5
(1) 212 449-9107 We assess the likelihood that the housing sector has entered into a “bubble”
Jose_Rasco@ml.com phase. There are numerous shades of gray, but when we examine the
Michele Chesnicka classic characteristics of a “bubble,” it seems to fit the bill.
VP, Associate Economist
(1) 212 449-2329 Charts of the Week 15
Michele_Chesnicka@ml.com Proprietary Indexes 16
Ron Wexler Key Market Movers (Economic Indicators, Debt Issuance, and Policy
VP, Economist
(1) 212 449-2705 Speakers) 17-21
Ron_Wexler@ml.com Q2 Earnings Update 22
Bobby Briones
Tables (Historical Economic Data, Economic Forecast Summary, Financial
Associate Economist
(1) 212 449-5887 Market Forecast and Rolling Calendar of Business Indicators 25-28
Bobby_Briones@ml.com
Nonfarm Payrolls: Is This As Good As It Gets?
Monthly Change, in Thousands
400

200

-200

-400
01 02 03 04

Source: Bureau of Labor Statistics.

Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware
that the firm may have a conflict of interest that could affect the objectivity of this report.
Investors should consider this report as only a single factor in making their investment decision.

Refer to important disclosures on page 29.

Global Securities Research & Economics Group RC#40321909 Economics Department

Anemic July employment report
raises questions about the
strength of the labor market.
However, the Fed looks
determined to raise rates at a
‘measured’ pace — 25 bps at
each of the next three meetings.
The underlying employment
details were not as bad —
production and income should
be strong in July.
A blend of fundamental and
quantitative methods were used
to formulate the rate forecast.
2 Refer to important disclosures on page 29.
The Market Economist – 6 August 2004
View From The Desk
Fed To Stay The ‘Measured’ Course
Turns out that the declines registered in the Chicago PMI, ISM manufacturing and
ISM non-manufacturing employment diffusion indices were the correct indicators
to focus on for this morning’s employment report. The July nonfarm payroll count
of 32,000 was well below the consensus forecast of 240,000 and even lower than
the whisper numbers of below 200,000. In addition to the anemic July print, we
saw a net downward revision of 61,000 to the previous two months, introducing
further concern about the strength of the labor market. We tend to get downward
revisions when the economy is slowing and upward revisions when the economy’s
growth is accelerating. Despite the weakness in the headline payroll figures, we
do not believe this alters the Fed's plan to raise rates at a ‘measured’ pace, which
would include 25 bps at the next three meetings pushing the funds rate to 2.0%.
The Fed has clearly communicated that they believe the Fed funds rate is just too
low and want to get back to a more neutral rate. And in doing so, are willing to
look past any so-called temporary weakness in the economy.
Not that we agree with the Fed’s view on the economy, but we must take them at
their word! And if the Fed does not go as advertised, they risk losing credibility.
Moreover, FOMC officials can point to the household survey and implications for
income and production from the report to say that this is not a complete disaster
for the economy. Manufacturing employment was up 10,000 and the
manufacturing workweek rose six minutes, resulting in a 0.4% increase in
manufacturing aggregate hours worked and likely a strong 0.7% increase in
industrial production on the month. Also, total aggregate hours worked rose 0.3%
and average hourly earnings increased 0.3%, pointing to a decent 0.5% advance in
personal income for the month. Furthermore, the household survey, while less
reliable than the payroll survey, did report a drop in the unemployment rate to
5.5% from 5.6% as employment in that survey jumped 629,000, eclipsing the
577,000 expansion in the labor force. And the labor participation rate rose 0.2% to
66.2%.
That all said, we believe that the weak data support our call that the Fed will stop
tightening much sooner and at a much lower level — 2.5% by the end of Q1 —
than the markets have been pricing in. The Fed may be determined to raise rates
in the near-term, but today's data show that the interest-rate sensitive sectors of the
economy, finance, construction, and retail are already feeling the pinch of higher
rates. Job losses in the finance sector were 23,000, losses in the retail sector were
19,000, and the construction sector only posted a meager 4,000 gain. Next week's
FOMC statement will be key in how it characterizes the economy at this point. If
the Fed intends to change course, they will have the opportunity and the
responsibility to communicate that to the markets at next week’s FOMC confab.
However, we are expecting the Fed to stay the ‘measured course.’
Below is an excerpt from the inaugural Interest Rate Outlook publication that
detailed our new Fed funds rate and yield curve forecasts (published on Thursday,
August 5th) (see Table 1 on the following page and repeated again on page 27).
These forecasts were generated by the newly-formed Interest Rate Committee1
that brings together a blend of macro economic fundamentals and quantitative
analyses.
1
Committee members are Dave Rosenberg, Chief North American Economist, Kathleen Bostjancic,
Senior Economist, Jim Caron, Head Cross Rate Strategy and Alex Patelis, Head G10 FX Strategy.
 The Market Economist – 6 August 2004

Table 1: Interest Rate Forecast

Quarters Years
Percent, End of Period 2004:3 2004:4 2005:1 2005:2 2005:3 2005:4 2004 2005
Fed Funds 1.75 2.00 2.50 2.50 2.50 2.50 2.00 2.50
3-Month T-Bill 2.00 2.25 2.65 2.55 2.50 2.50 2.25 2.50
3-Month LIBOR 2.00 2.35 2.75 2.70 2.65 2.65 2.35 2.65
2-Year T-Note 3.00 3.25 3.45 3.00 2.90 2.85 3.25 2.85
5-Year T-Note 4.05 4.35 4.40 3.90 3.75 3.65 4.35 3.65
10-Year T-Note 4.75 5.00 4.90 4.65 4.30 4.15 5.00 4.15
30-Year T-Bond 5.40 5.55 5.65 5.40 5.10 4.95 5.55 4.95

Real GDP (annualized) 3.0 3.5 2.5 3.3 3.0 2.8 4.2* 3.0*
Core CPI (Year/Year) 2.2 2.2 2.1 1.9 1.6 1.9 1.9* 1.9*
Budget Balance ($ Bil. **) -450 -385
Current Account ($ Bil.**) -592 -595
Source: Merrill Lynch
* Annual Average % Change **Cumulative Balance on a Fiscal Year Basis ***Cumulative Balance on a Annual Basis

We forecast Fed funds to be 2%
by year-end and peaking at
2.5% in 1Q05.
Fiscal drag to replace fiscal
stimulus in 2005… Inflation
expected to remain subdued.
Estimating equilibrium Fed
funds rate and using the
‘Taylor Rule’ forms the basis of
our fundamental approach.
Focusing on the Fed funds rate forecast, it now looks very clear after Fed
Chairman Greenspan's mid-year Congressional testimony two weeks ago that
policymakers believe that the current 'soft patch' in the economy is transitory and
that the Fed will be looking through weak economic news. However, they will be
treating any above-expected core inflation data with concern and likely a more
aggressive tightening posture. While the base case is that the Fed moves in a
'measured' fashion, which is still its objective, we now see three more rate hikes
this year (August 10th, September 21st and November 10th) which brings the
funds rate to 2% by year-end. And we see another 50 basis points of tightening
early next year bringing the funds rate to 2.5%, which we view as being a neutral
rate consistent with meeting the Fed's dual goals of nurturing a stable price
environment and achieving full employment.
We believe that with profit growth slowing and the pace of job creation likely to
follow suit with the typical 3-6 month lag, higher market rates, signals from the
equity market, and fiscal drag to replace fiscal stimulus through 2005, the
economy is unlikely to overheat by growing above potential. Against that
backdrop, any inflation outbreak will probably prove short-lived. We were
particularly encouraged by the latest set of inflation data for June — PPI down
0.3%, core import prices flat, core CPI only up 0.1% and average hourly earnings
also rising just 0.1% on the month and a non-inflationary 2.0% year-on-year. The
money supply data have also been quite tame, with the year-to-year pace in M2
now at 3.6%, so there is no evidence of excessive monetary creation despite the
current low funds rate.
A natural starting point in the ‘normalization’ process that the Fed is embarking on
is to first estimate an ‘equilibrium’ level for the Federal funds target. Such a level
would be consistent with a variance of the so-called ‘Taylor rule,’ which
essentially tries to quantify the Fed’s dual employment and inflation mandate in an
easy-to-understand framework. In the rule we assume potential GDP growth of
3.5%, which is consistent with the Fed’s recent central tendency forecasts, the
Fed’s implicit inflation target of 2% and an equilibrium real interest rate of 1.0%.
The latter assumption is probably the most controversial; we feel it is
appropriately low given the low starting point of inflation and the high levels of
debt that currently characterize the U.S. economy.
Taken these figures as given, we create a matrix of the level of Fed funds for
various real growth and inflation forecasts (see Table 2 on the next page). The
current forecasts of the U.S. economics group (real GDP growth of 2.9% Q4/Q4
and core CPI inflation of 1.9%) for 2005 imply a nominal Federal funds rate of
around 2.5%, which is at the lower end of our 2.5% - 3.0% forecast for the neutral
Fed funds rate.

Refer to important disclosures on page 29. 3

 The Market Economist – 6 August 2004

Table 2: Equilibrium Fed Funds (%)

Real GDP Growth (%)
1 2 3 4 5 6
1 0.0 0.4 0.9 1.4 1.8 2.3
Core 1.5 0.7 1.2 1.6 2.1 2.6 3.1
Inflation 2 1.4 1.9 2.4 2.9 3.3 3.8
(%) 2.5 2.2 2.7 3.1 3.6 4.1 4.6
3 2.9 3.4 3.9 4.4 4.8 5.3
3.5 3.7 4.2 4.6 5.1 5.6 6.1
4 4.4 4.9 5.4 5.9 6.3 6.8
4.5 5.2 5.7 6.1 6.6 7.1 7.6
5 5.9 6.4 6.9 7.4 7.8 8.3
Source: Merrill Lynch, our calculations.

Fed to only reach the lower end
of our estimated ‘neutral’ Fed
funds level at 2.5%.
Economic growth is expected to
remain below potential over the
next several quarters.
Sharp dollar weakness that
creates reduced demand for
Treasuries presents a risk to
our forecast.
We believe the Fed only reaches the lower-end of the neutral Fed funds forecast
range since the economy will still have a negative output gap by the end of 2005
according to our GDP forecast, an indication of excess capacity. In terms of the
timing, with the Fed raising rates at a ‘measured’ pace, and GDP growth likely to
decelerate to a 2.5% annualized rate by Q1 2005 on our forecasts, it is reasonable
to expect the peak in the Federal funds rate to be around 2.5% by that date. We
feel strongly that it is necessary to overlay a cyclical to the structural component
of our Fed funds forecast. A cyclical downturn limits the degree of the
‘normalization’ process.
On a near-term basis, economic growth will probably remain below potential in
our view — hence our belief that the Fed can still be ‘measured’ in raising interest
rates. That said, we do believe that the risk is for a more hawkish Fed near-term,
which will establish a floor under the yield curve and raise the chances that market
rates drift to the high end of the recent 4.35%-4.90% range on the 10-year
Treasury. Investor sentiment is already at bearish extremes so we would not be
surprised to see investors use such a move as a buying opportunity in the absence
of any renewed inflation scares. If we prove correct on our monetary policy call
that the Fed intends to move to so-called neutrality by establishing a modest
positive inflation premium to the funds rate, curve dynamics suggest that 4% on
the 10-year could be re-tested by late 2005. A full description of the methodology
and analyses behind our yield curve forecasts, please see the Interest Rate Outlook
published on August 5.
Risks to the forecast, beyond inflation surprises, would involve exogenous events
that could trigger a destabilizing decline in the dollar — such as a Chinese
revaluation or a Bank of Japan policy tightening which could affect foreign
demand for Treasuries. We are well aware of these risks, but in our view the
consumer will be soft enough to trigger a slowdown in import demand in the
coming quarters and the J-curve effect of years of dollar weakness has begun to be
reflected in an improved export performance, both of which should help reduce
the current account deficit and bloated foreign borrowing requirements from
current peak levels. The election and fiscal policy is another wild card, but no
matter who emerges victorious in November, budgetary restraint and lower
deficits are likely on their way through 2005, though a Kerry win would probably
be viewed more bond positive than a Bush victory because Senator Kerry is seen
more as a fiscal hawk.
David Rosenberg, FVP, Kathleen Bostjancic
Chief North American Economist Director, Senior Economist
(1) 212 449-4937 (1) 212-449-2650

4 Refer to important disclosures on page 29.

 The Market Economist – 6 August 2004

Hot Topic
Housing: If Not a Bubble Then an Oversized Sud
Classic traits of a bubble: In this report, we assess the likelihood that the housing market has entered into a
(i) Extended valuation “bubble” phase. There are numerous shades of gray, but when we examine the
(ii) Over-ownership classic characteristics of a “bubble” (extended valuation, over-ownership,
excessive leverage, a surge in supply, complacency (denial?), and speculative
(iii) Excessive leverage behavior, it seems to fit the bill. At the very least, housing is overextended, and
(iv) Supply surge even the Fed has acknowledged as much. The next question is what pricks the
(v) Complacency “bubble” if in fact there is one, and the answer to that boils down to two words:
(vi) Speculation. interest rates. While the trend in personal income is also a key determinant of
housing demand and pricing, our research finds that the impact of mortgage rates,
basis point for basis point, is three times as powerful as household earnings
growth (for more, please see the June 4 issue of The Market Economist).
“Reports from some contacts suggested that speculative forces might be boosting
housing demand in some parts of the country, with concomitant effect on prices,
suggesting the possibility that house prices might be moving into the high end of
the range that could be consistent with fundamentals.” (FOMC Minutes —
March 16, 2004.)
Even the Fed knows that “To be sure, indexes of house prices based on repeat sales of existing homes have
housing is overextended. outstripped increases in rents, suggesting at least the possibility of price
misalignment in some housing markets. A softening in housing markets would
likely be one of many adjustments that would occur in the wake of an increase in
interest rates.” (Fed Chairman Alan Greenspan — May 6, 2004.)
“The key features of a bubble are that the level of prices has been bid up beyond
what is consistent with underlying fundamentals and that buyers of the asset do so
with the expectation of future price increases.” (NY Fed, July 2004.)

Are Those Bubbles Blowing From My Backyard?

The P/E ratio for the housing

sector, proxied by the home
price/rental rate ratio, has
surged to record highs of
roughly 1.40x. If this metric
were to ever mean-revert, it
would imply either a 15%
decline in average housing
prices over the next year or
stagnant real estate values
through 2011. That’s how
overvalued the market is.

Refer to important disclosures on page 29. 5

 The Market Economist – 6 August 2004

Bubble #1: Extended Valuation — This Is The P/E Ratio for Housing (Look Familiar?)

OFHEO Index / CPI: Imputed Rent

Rati o
The P/E equivalent for the
1. 425 1.425
housing sector — home prices
divided by the cost of renting —
has soared to a record high. To 1. 350 1.350

bring this ratio back into line

with the historical norm, and
1. 275 1.275
assuming that rental rates edge
up at their traditional pace,
average house prices would 1. 200 1.200

have to decline 15% over the

next year. Alternatively, it
1. 125 1.125
would take almost seven years
of stagnant home prices to
achieve the same mean- 1. 050 1.050
85 90 95 00
reverting result.

Source: Bureau of Labor Statistics, Office of Federal Housing Enterprise Organization. Note: In our calculation we
assumed that rent prices would edge up by 3.1% per year (the 10-year average) and the average ratio between the two
series is 1.15 (average from 1983 to 2000).

Bubble #1: Another Sign Of An Over-Priced Market — Stretched Affordability

Due to higher lending rates,
soaring home prices, and Composite Housing Affor dability Index
lagging wage growth, housing Medi an Inc=Qual i fyi ng Inc=100
affordability plunged in June, 150 150
the fourth decline in a row.
Affordability is now at its lowest 145 145
level since August 2000 and can
be expected to cut into housing 140 140
demand — and perhaps even
prices — in the coming months.
135 135
For example, the last time
affordability fell to this level,
130 130
median new home prices
decelerated to low single-digit
125 125
growth terrain in the ensuing
year. Even with low mortgage
120 120
rates, first-time buyers have
99 00 01 02 03 04
strapped on so much mortgage Sour ce: Nati onal Associ ati on of Real tor s /Haver Anal yti cs
debt that roughly 1/3 now pay
at least 30% of their after-tax
income on shelter (and half of
the lowest income households
spend at least 50% of their
incomes on housing).

6 Refer to important disclosures on page 29.

 The Market Economist – 6 August 2004

Bubble #2: Over-Ownership/Democratization Of The Market (Here’s My Card!)

Homeowner ship Rate: United S tates
SA, %
Democratization and/or over-
70 70
ownership is a classic
characteristic of a bubble.
Housing certainly fits the bill
68 68
given that the homeownership
ratio has hit a record high of
almost 70%. Remember in the
66 66
late 1990s that investor
participation in the equity
market surged to levels that 64 64
were last posted in the roaring
1920s. “Herd effect” and
“caveat emptor” tend to go 62 62
hand-in-hand. 85 90 95 00
Sour ce: Ce nsus Bur eau /H aver Anal yti cs

Bubble #2: Over-Ownership Has Translated Into Record Real Estate Exposure

Household Real Estate Assets

(% of Total Assets)

30 30

Roughly 28% of household

assets are tied up in residential 28 28
real estate, piercing the prior
three peaks in this ratio. This is
just another example of how 26 26

“over-owned” this sector is.

24 24

22 22

20 20
60 65 70 75 80 85 90 95 00

Source: Federal Reserve Board, Merrill Lynch.

Refer to important disclosures on page 29. 7

 The Market Economist – 6 August 2004

Bubble #2: Real Estate Assets Far Outstripping Income Trends

Real Estate Assets

(% of D i sposabl e Income)

200 200

Similarly, real estate assets on

the household balance sheet 190 190
relative to disposable income —
a relatively stable ratio up until
180 180
the late 1990s — has literally
exploded to the upside. This
ratio, which stood at 165% 170 170
before the last leg of the
housing boom began four years
160 160
ago, is at an all-time high of
195% today.
150 150
80 85 90 95 00

Source: Federal Reserve Board, Merrill Lynch.

Another defining characteristic Bubble #3: Excessive Leverage — Mortgage Market Now Over 30% Of Total Debt
of a “bubble” is extensive
leverage. The accompanying
Mor tgage Debt
chart depicts a stable series
throughout most of the 1990s, (% of D omesti c Nonfi nanci al Debt)

but has since exploded. Some 32 32

would argue that this chart
makes perfect sense given the 30 30
ultra-low interest rate
environment and not 28 28
surprisingly, more households
have opted to own rather than 26 26
rent. However, this line of
thinking reminds us of a similar 24 24
chart showing NASDAQ
valuation circa 1999-2000 when
22 22
we were told not to worry
because investors were making
20 20
the logical choice of shifting 80 85 90 95 00
out of cash and bonds into the
land of the “new paradigm.” Source: Federal Reserve Board, Merrill Lynch.

8 Refer to important disclosures on page 29.

 The Market Economist – 6 August 2004

Bubble #3: Housing Market And Banking Sector Performance Joined At The Hip

Real Estate Loans

(% of Bank Cr edi t)

38 38
Real estate lending for
commercial banks, a key source
of profits, is up 10% year-over- 36 36
year and now comprises a
record 37% share of total bank
credit, up from 35% a year ago,
34 34
and 33% two years ago. Now
we know why Richard
Bernstein our Chief Investment
32 32
Strategist has put Financials on
the watch list for a potential
downgrade.
30 30
00 01 02 03 04

Source: Federal Reserve Board, Merrill Lynch.

Another way of seeing just how

levered the consumer has
gotten is to look at the Bubble #3: LTV Ratios Near Record Highs (Did You Say “1% Down”?)
aggregate loan-to-value ratio
Household M or tgage-to-Real Estate Value Ratio
for real estate. This ratio is
hovering near an all-time high
of 45% on the household 0 . 46 0.46

balance sheet. The flip side to

that argument is that 0 . 45 0.45

households, in the aggregate,

own only 55% of their home,
0 . 44 0.44
hovering near an all-time low.
This, in part, reflects aggressive
lending behavior this cycle as 0 . 43 0.43

well as the record pace of

mortgage cash-outs. Existing 0 . 42 0.42
homeowners have effectively
borrowed against the rising
0 . 41 0.41
notional price of their house. 93 94 95 96 97 98 99 00 01 02 03

Much like the tech stock boom

of the late 1990s, the housing Source: Federal Reserve Board.
market boom has also attracted
an increasing number of
marginal buyers. For example,
subprime mortgage lending has
risen at an estimated 25%
average annual rate over the
last decade.

Refer to important disclosures on page 29. 9

 The Market Economist – 6 August 2004

Bubble #3: The 2001-2004 Cash-Out Craze (Poof! The House Becomes a Credit Card)
Total Home Equity Cashed Out
According to Freddie Mac, the (Billions $)

dollar volume of equity cash- $160.0

outs through mortgage $138.1
$140.0
refinancings ballooned 27% in
$120.0
2002 to $105 billion and $105.4
another 31% to $138 billion in $100.0
$82.9
2003. While cash-outs are seen $80.0 $71.7
at $72 billion this year, this $60.0
would still be almost six times $39.9 $37.0
$40.0 $26.2
the level posted during the mid- $19.9
$13.8 $11.2 $17.4 $21.4
$20.0
1990s (back then, of course,
$0.0
individuals were too focussed
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 F
on margin debt to buy stocks).
Source: Freddie Mac.
Annual Cash-Outs For All Prime Conventional Loans

Bubble #4: Supply Taking Over — The Builders Have Gotten Restless

Housing Star ts (% of Employment)

6 Month Movi ng Aver age
The homebuilders have sharply 1.4 1. 4
ramped up supply, conjuring up
memories of the late-stage
production burst in the tech
1.2 1. 2
sector in 1999-2000. Housing
starts normalized by
employment is flirting near 17-
1.0 1. 0
year highs and is about 24%
higher than the average of the
last 15 years (1.2).
0.8 0. 8

0.6 0. 6
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Source: Bureau of Labor Statistics, Census Bureau, Merrill Lynch. Note reference line denotes average since 1990 =
0.97. The June reading was 1.206.

10 Refer to important disclosures on page 29.

 The Market Economist – 6 August 2004

Bubble #4: National Housing Vacancy Rate—New High

Total Vacant Housing Stocks as a share of Total Housing Units (ratio)

H VU / H S T K

0 . 13 5 0 . 13 5
In fact, the national inventory
of unsold homes as a share of 0 . 13 0 0 . 13 0
the housing stock has broken
out sharply in the past 12-24 0 . 12 5 0 . 12 5
months. The question is, with
even more supply on its way, 0 . 12 0 0 . 12 0
and affordability levels waning,
will home prices become 0 . 11 5 0 . 11 5

vulnerable?
0 . 11 0 0 . 11 0

0 . 10 5 0 . 10 5
91 92 93 94 95 96 97 98 99 00 01 02 03 04

Source: Census Bureau.

Bubble #4: Look At What Has Happened To Rental Vacancy Rates

Rental Vacanc y Rate: United States

%
1 0. 5 0 10. 50

Another factor that may put 9 . 75 9. 75

downward pressure on home

prices is the surge in rental 9 . 00 9. 00
vacancy rates. At the margin,
renting has become a more
8 . 25 8. 25
economical proposition.

7 . 50 7. 50

6 . 75 6. 75
92 93 94 95 96 97 98 99 00 01 02 03
Sour ce: Ce nsus Bur eau /H aver Anal yti cs

11Refer to important disclosures on page 29. 11

 The Market Economist – 6 August 2004

Bubble #5: Denial Sets In (Complacency At The Very Least)

Cur r ent Conditions for Buying Houses: Good: Pr ices Going Higher
%

8 8

Talk about chasing the market.

Despite lofty valuations on new
6 6
homes, households have
become increasingly convinced
that real estate will continue to
generate solid returns. The 4 4

share of households looking to

get into real estate due to the
price action has risen to its 2 2

highest level in roughly four

years.
0 0
A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J
02 03 04
Sour ce: Uni ver si ty of Mi chi gan /Haver Anal yti cs

Bubble #5: Still A Good Investment After a Five-Year, 35% Run-up?

Another 10% of households

believe that housing is a good Cur r ent Conditions for Buying Houses: Good: Good Investment
investment right now, at the %
high end of the historical range 12 12
and roughly double the long
run average of 6%. It is
interesting that in mid-1998, a 10 10

low of 3% believed housing to

be a good investment and that 8 8
followed a five-year period in
which average new home prices
rose 20%. Fast forward to 6 6

today, and we have more than

tripled the share who are of that 4 4
bullish view and this follows a
five-year run of 35% home
price appreciation. What would 2 2
85 90 95 00 05
a contrarian say? Sour ce: Uni ver si ty of Mi chi gan /Haver Anal yti cs

12 Refer to important disclosures on page 29.

 The Market Economist – 6 August 2004

Bubble #5: “House Prices Never Go Down” (A Myth of Zeus-Like Proportions)

Existing 1-Family Homes: Median Sales Pr ice

It is widely perceived that house
% Change - Year to Year Thous. $
prices never decline, which is
really “new era” thinking. 12. 5 12. 5

While this is true since the

housing boom began in the 10. 0 10. 0

mid-1990’s we managed to find

no fewer than four occasions 7.5 7.5
when median prices in the
resale market fell on a year- 5.0 5.0
over-year basis — usually
following interest rate cycles. 2.5 2.5
Note that in the higher inflation
days of the late 1980s and early 0.0 0.0
1990s, the house price declines
in “real” terms was rather -2. 5 -2. 5
substantial (i.e. roughly -10%). 90 95 00 05
Sour ce: Nati onal Associ ati on of Real tor s /Haver Anal yti cs

Bubble #5: There Was Also Complacency at NASDAQ 5000 (New Era In Housing?)

To be sure, there are limits in

Stock Pr ice Index: NASDAQ Composite [-50]
comparing housing, as an asset Feb-5-71=100

class, to equities. But the Existing 1-Family Homes: Median Sales Pr ice
similarities in the price action Thous. $
5000 200
between what we saw in the 4000
stock market in the late 1990s 180
3000
and what we are seeing today in
160
residential real estate seem to 2000

share at least some 140

resemblance. Every “bubble”
1000
ultimately pops — this is why
120
the interest rate outlook is so
important since aggressive Fed 500
tightening would probably be a 100

trigger point.

200 80
90 95 00 05 10
Sour ces: WSJ, REALTOR /Haver

Note: NASDAQ Composite moved forward by 50 months. Scales are in log terms. NASDAQ (line) on the left hand scale.
Home prices (bars) on the right hand scale.

Refer to important disclosures on page 29. 13

 The Market Economist – 6 August 2004

Bubble #6: Housing Turnover Jumps To An All-Time High in Q2:2004

Turnover = Total home sales/housing stock.

7.0%
Another potential sign that a 6.5%
housing “bubble” is brewing, is 6.0%
the increase in speculative 5.5%
behavior. Housing turnover
5.0%
has surged since the end of
4.5%
2003, and now stands at an all-
time high. According to 4.0%
Dataquick Information 3.5%
Services, homes that were 3.0%
bought and sold by the same 2.5%
owner within six months has 2.0%
risen 54% in the past year in
03/01/1968

03/01/1970
03/01/1972

03/01/1974
03/01/1976

03/01/1978
03/01/1980

03/01/1982

03/01/1984
03/01/1986

03/01/1988
03/01/1990

03/01/1992
03/01/1994

03/01/1996

03/01/1998
03/01/2000

03/01/2002
03/01/2004
Chicago; 83% in Fort Worth
and a near-doubling in Orange
County. The flippers are back.
Source: Census Bureau, National Association of Realtors, Merrill Lynch. Note: Turnover = total home sales/ housing
stock.

Dave Rosenberg, FVP Ron Wexler, VP

Chief North America Economist VP, U.S. Economist
(1) 212 449-4937 (1) 212 449-2705

14 Refer to important disclosures on page 29.

 The Market Economist – 6 August 2004

Charts of the Week

Chart 1: 12-Month Expectations of Change in Prices: Mean Increase
Inflation expectations look to Expected Change in Prices
have peaked. According to the 7

University of Michigan survey, 6

12-month inflation expectations
fell to 3.50, the lowest reading 5

since February. These results 4

are in line with the pricing
power component of the ISM 3

index. 2

0
90 92 94 96 98 00 02 04

Source: University of Michigan.

Chart 2: Has the ISM Manufacturing Index Reached it Peak?

In our view, the ISM has
clearly peaked for the cycle. ISM Index vs. Real GDP
Diffusion Index Percent Change Year Ago
While still at lofty levels, the 65 6
index is off its high seen last
January and has generally been 60

hovering in a range over the 4

55
last five months.
50 2

45
0
40 ISM Index (Left)
Real GDP (Right)

35 -2
90 92 94 96 98 00 02 04

Source: Institute of Supply Management, Bureau of Economic Analysis.

Chart 3: The First Drop in Private Residential Construction in 15 Months

Value of P rivate Residential Construction P ut in P lace

Percent Change from Previous Month
Overall construction spending 3

in June fell 0.3% month-on- 2

month, but the residential
1
component was especially weak,
dropping 0.6%. This decline 0
broke a 15-month streak, and -1
was the largest monthly decline
since 9/11. -2

-3

-4

-5
00 01 02 03 04

Source: Census Bureau.

Refer to important disclosures on page 29. 15

 The Market Economist – 6 August 2004

Merrill Lynch Proprietary Weekly Indicators

Chart 1: Production Index Chart 2: Consumer Index

Production Looks to Have Bounced Back in July Has the Consumer Run Out of Steam?
Index, 4 Week Average Index, 4 Week Average Index Index
156 156 0.14 0.14

153 153
0.07 0.07

150 150
0.00 0.00
The ML Consumer Index
147 147 Flashing Sluggish Start to Q3

-0.07 -0.07
144 144
The ML Production Index
is up 1% in July
141 141 -0.14 -0.14
JUL OCT JAN APR JUL OCT JAN APR JUL JAN APR JUL OCT JAN APR JUL
2002 2003 2004 2003 2004
Source: Merrill Lynch Source: Merrill Lynch

The ML production index finished the month up by 1%. As we noted last week, the
true underlying trend in production is probably weaker than the headline growth rate
suggests. The later than usual plant closures, biased our production index upwards in
early July (due to the seasonals). Over the last couple of weeks the seasonals have
worked in the opposite direction. Momentum heading into August looks weak.
The ML Consumer Index was flat for a third week in a row. The ABC/Money Magazine
consumer sentiment index inched slightly higher and both initial and continuing claims
fell on the week, but energy prices continued to rise, and chain store sales continued
to disappoint. It looks like consumer spending is off to a slow start in Q3.

Chart 3: Housing Index Chart 4: Financial Stress Index

Recent Spike in Rates Will Cool Off Housing Market in 2H04 Financial Stress Eases - But Will it Last?
Index Index Index Index
1.2 1.2 2.0 2.0
Risk Aversion
1.5 +1 Standard Deviation 1.5

0.6 0.6
1.0 1.0

0.5 0.5
0.0 0.0
0.0 0.0

-0.5 -0.5
-0.6 ML Housing Index Hovering Near -0.6
Lows We Haven’t Seen Since Nov 2001
-1.0 Risk Taking -1.0
-1 Standard Deviation
-1.2 -1.2 -1.5 -1.5
AUG NOV FEB MAY AUG NOV FEB MAY AUG NOV FEB MAY AUG JAN JUL JAN JUL JAN JUL JAN JUL
2001 2002 2003 2004 2001 2002 2003 2004
Source: Merrill Lynch Source: Merrill Lynch

The ML Housing Index is beginning to stabilize, but the level of the index is consistent
with a deceleration in housing activity in 2H. Real estate loans have slowed sharply
now growing at 8.7% annual rate (13-week basis), the slowest growth rate since mid-
February. In fact, real estate loan growth has been slowing for ten weeks in a row.
Moreover, the MBA purchase index, while still at very high readings, seems to have
peaked.
Our Financial Stress Index has shown a decline in risk aversion over the last couple of
weeks. The main reasons for the move have been the decline in gold prices and the
Swiss Franc, and the fact that the put-to-call ratio sank to the lowest reading since late
June during the last week of July. In our view, this will most likely turn out to be a
temporary blip (especially in light of the most recent spate of weak economic data).
The VIX is turning higher. Corporate spreads are off their lows. Staples continue to
outperform TMT stocks. And with the market continuing to discount aggressive Fed
easing, we would expect bonds to outperform. Stay defensive.

Ron Wexler
VP, U.S. Economist
(1) 212 449-2705

16 Refer to important disclosures on page 29.


Despite the weak employment
data for July, we expect the
FOMC to raise rates next
Tuesday.
Retail sales should bounce back
in July. The PPI report should
show benign inflation.
Inventory accumulation
continued through June,
especially at the wholesale
level.
Slower economic growth,
combined with a rise in hours
worked hurt productivity in Q2.
The Market Economist – 6 August 2004
Key Market Movers
For the financial markets, the highlight next week will be the Fed. On Tuesday,
the FOMC meets and we expect them to raise the Fed funds rate 25 basis points to
a 1.5%. Despite the recent weak economic data, Merrill Lynch’s newly-formed
Interest Rate Committee expects the Fed to continue to raise the funds rate to 2.0%
by year-end in an effort to reach a more neutral funds rate. On Thursday, August
12th we will get the minutes from the June FOMC meeting, which should provide
some additional color on the views of the FOMC members as they began to raise
rates.
On the data front, there are two key releases next week: retail sales and the PPI.
We are looking for retail sales to rebound sharply in July after the dismal 1.1%
drop in June. Despite this increase in sales, the momentum going into the third
quarter is negative and thus, consumer spending will be weaker than most expect.
The PPI should be to the Fed’s liking. We are looking for very modest gains in
producer inflation in July. Discounting of cars and computers, along with weaker
food and energy prices should keep inflation in check in July. Another important
indicator next week will be the University of Michigan’s consumer sentiment
index for the month of August, which should edge slightly higher.
We will also get second quarter productivity data. We expect to see a slowing in
productivity from the first quarter, and an acceleration in labor costs, which we
have not seen since 2001.
n Monday, August 9, 2004
Wholesale Inventories, June – 10:00 am
Exp. Consensus Range History
Wholesale Inventories +0.5% +0.6% +0.3% to +1.0% May = +1.2% vs. Apr. = +0.2%
Source: Merrill Lynch, Bloomberg
We expect wholesale inventories to rise 0.5% in June, after posting a large 1.2%
gain in May. Inventory accumulation was much stronger than anticipated in the
Q2 NIPA accounts, implying another healthy gain in wholesale inventories in
June. Moreover, imports were probably strong in June, which is another indicator
that suggests that wholesale inventories will rise.
n Tuesday, August 10, 2004
Productivity, 04Q2 Preliminary – 8:30 am
Exp. Consensus Range History
Productivity +2.0% +2.0% +0.3% to +3.6% 04Q1 = +3.8% vs. 03Q4 = +2.5%
Unit Labor Costs +2.5% +2.0% +0.7% to +4.4% 04Q1 = +0.8% vs. 03Q4 = +1.7%
Source: Merrill Lynch, Bloomberg
Productivity should rise at a 2.0% annual rate in the second quarter. This is
weaker than the 3.8% rate we saw in the first quarter. From the annual revisions
to the NIPA data, we know that non-farm output rose at a 3.8% annual rate in the
second quarter. With hours worked rising at roughly a 1.8% rate, it left
productivity rising at its slowest pace since the second quarter of 2002. We
estimate that compensation per hour rose at a 4.5% rate, which is in line with the
4.6% pace we saw in Q1. The end result is that unit labor costs should rise 2.5%
for the quarter. This represents the third consecutive rise for unit labor costs and
would be the fastest gain in labor costs since the first quarter of 2001.
Refer to important disclosures on page 29. 17

The budget deficit rose in July
as outlays continued to outstrip
revenue growth.
Jobless claims remain range-
bound suggesting layoffs are
not accelerating.
Higher oil prices should boost
import prices.
18
The Market Economist – 6 August 2004
n Wednesday, August 11, 2004
Treasury Statement, July – 2:00 pm
Exp. Consensus Range History
Treasury Statement -$61.0B -$60.0B -$70.6B to -$40.0B July ’03 = -$54.2B
Source: Merrill Lynch, Bloomberg
We expect the July budget balance to register a deficit of $61.0 billion, $7 billion
deterioration from the $54 billion shortfall recorded a year ago. The year-on-year
deterioration continues to be led by growth in outlays outstripping revenue
growth. Spending growth is running a full three percentage points ahead of the
pace revenues at 6.6% year-on-year versus just 3.6% for revenues. With just two
months remaining before fiscal year-end, we look for the budget deficit to be $450
billion for the full fiscal year. Looking ahead to fiscal year 2005, we foresee a
moderate narrowing in the deficit to $385 billion as revenues rebound a strong
11%, in tandem with an improving labor market. Spending growth, despite
attempts to reign in non-defense discretionary outlays, is poised to slow only
gradually to a 5.9% pace.
n Thursday, August 12, 2004
Jobless Claims, week ending August 7 – 8:30 am
Exp. Consensus Range History
Jobless Claims 340,000 340,000 330,000 to 340,000 Week ending 7/31/04 = 336,000
Source: Merrill Lynch, Bloomberg
We estimate that initial unemployment claims will edge up for the week ending
August 7 to 340,000 from 336,000 in the prior week. This would nudge the four-
week average down to 341,000 from 343,500. Given that the factory shutdowns
have already taken place, there probably were not any major layoffs during that
week.
Import Prices, July – 8:30 am
Exp. Consensus Range History
Import Prices +0.4% +0.4% -1.3% to +0.8% June = -0.2% vs. May = +1.4%
Source: Merrill Lynch, Bloomberg
Import prices probably rose 0.4% in July, which would leave them 5.5% above
last July’s levels. This would represent a rebound from last month’s 0.2% decline,
but far below the 1.4% surge we saw in May. Part of the push in import prices
was due to the higher cost of imported crude oil, which was up 8% in.
Commodity prices were up more modestly in July, as the CRB raw industrial
materials index rose only by 0.1% for the month.
Refer to important disclosures on page 29.

Retail sales should rebound in
July, but will probably remain
below the 2Q average,
suggesting weak spending in
Q3.
While auto sales surged in July,
gas prices fell and chain store
sales were weak.
Inventories probably closed out
the second quarter on a strong
note.
The trade deficit probably
widened slightly in June.
The Market Economist – 6 August 2004
Retail Sales, July – 8:30 am
Exp. Consensus Range History
Retail Sales +0.8% +1.1% +0.3% to +2.2% June = -1.1% vs. May = +1.4%
Retail Sales Ex-Autos +0.2% +0.4% 0.0% to +0.8% June = -0.2% vs. May = +0.9%
Source: Merrill Lynch, Bloomberg
Retail sales should rebound in July, rising 0.8%, after posting a dismal 1.1%
decline in June. Excluding autos, retail sales should rise at a more tepid pace of
0.2%, which would offset the 0.2% decline we saw in June.
Most of the strength in sales in July came from the vehicle sector. New vehicle
sales jumped 12% in July. One problem is that a good part of the strength in
vehicle sales of late has been from fleet sales, which do not necessarily get
counted in retail sales. If a fleet was purchased directly from the manufacturer, it
does not count as a retail sale. As a result, we may not see as powerful a kick
from unit vehicle sales as many are expecting.
Sales at gasoline service stations should be weaker given that prices were down
more than 3% in July. In fact, over the last few years, when gasoline prices have
declined in a given month, service station revenues declined 70% of the time.
However, the solid rebound we expect to see in retail sales in July, the level of
retail sales in July should still be 2.0% below the second quarter average level of
sales. Consumers will have to pick up the pace of purchases dramatically if the
economy is going to get a boost from the consumer in the third quarter.
Business Inventories, June – 10:00 am
Exp. Consensus Range History
Business Inventories +0.6% +0.5% +0.2% to +0.8% May = +0.4% vs. Apr. = +0.7%
Source: Merrill Lynch, Bloomberg
Business inventories should rise 0.6% in June. Since February, business
inventories have risen at least 0.5% in each month. We know from the various
diffusion indices that inventory accumulation probably picked up in June. The
ISM inventory index rose to 51.1 in June from 49.3 in May. This was the highest
point and the only reading above 50, since January 2000. We already know that
manufacturing inventories rose 0.7% in June, and we are estimating that wholesale
inventories rose 0.5% in June (see write-up on page 17). The one remaining
sector, the retail sector, probably posted a 0.5% gain in inventories in June. Retail
sales were down 1.1% in June, which usually results in a slight buildup in
inventories for the month.
n Friday, August 13, 2004
International Trade Balance, June – 8:30 am
Exp. Consensus Range History
International Trade -$46.4B -$46.5B -$51.3B to -$44.0B May = -$46.0B vs. Apr. = -$48.1B
Source: Merrill Lynch, Bloomberg
We estimate that the trade deficit widened slightly in June to $46.4 billion from
$46.0 billion in May. Exports probably rose 2.5% to $99.6 billion in June, after
rising 2.9% in May. U.S. exporters continue to benefit from the strong global
economy and the weaker currency, as the trade-weighted U.S. dollar fell in June,
making U.S. exports more competitive. We saw evidence of this in the June ISM
report. The ISM index of export orders remained quite strong in June at a level of
56.7. This followed three consecutive months of above 60.0 readings, a period in
which U.S. exports rose by more than 6%. We estimate that imports rose 2.0% in
Refer to important disclosures on page 29. 19

Weaker gasoline prices and
discounting in the auto and PC
businesses should keep
producer price inflation low.
Weekly surveys suggest that
consumer sentiment should rise
in early August.
20
The Market Economist – 6 August 2004
June. Custom duties jumped 15% and were up almost 19% from the prior June.
This is the fastest growth rate for customs duties since the 20% annualized surge
we saw in January 2003, when U.S. imports were up more than 14% on a year-on-
year basis. Another indicator of solid import growth in June was the ISM import
index, which stayed at a very strong 57.6 level from 59.8 in May.
Producer Price Index, July – 8:30 am
Exp. Consensus Range History
Producer Price Index +0.2% +0.3% -0.1% to +0.4% June = -0.3% vs. May = +0.8%
Core PPI +0.1% +0.1% 0.0% to +0.3% June = +0.2% vs. May = +0.3%
Source: Merrill Lynch, Bloomberg
The PPI should rise 0.2% in July, with the core rate edging up only 0.1%. On a
year-on-year basis, the PPI should be up 4.1%, in line with June’s 4.0% rise. We
expect the core rate to rise 1.8% from last July, which would represent a slowing
in the annual rate we saw in June (+1.9%).
Energy prices should have contributed to some price moderation. Gasoline prices
were down about 2.5% in July after seasonal adjustment, and the price of finished
energy products down 0.2% on the month.
We expect to see more price declines in the vehicle sector, as probably some of
the price discounting and better incentives most likely came directly from the
manufacturers. The result of these types of programs would be felt in the PPI,
which we estimate would push new car prices down 0.2% in July. Moreover,
given the glut of chips and other computer equipment, we would not be surprised
to see price discounting in that sector as well.
Consumer Sentiment (Univ. of Michigan), Early August – 9:50 am
Exp. Consensus Range History
Consumer Sentiment 98.0 98.0 95.0 to 100.0 July = 96.7 vs. June = 95.6
Source: Merrill Lynch, Bloomberg
Consumer sentiment should rise in the early August reading to 98.0 from 96.7 in
July. The weekly ABC/Money Magazine survey of consumer comfort rose
meaningfully in late July/early August and stood at -6 at the end of July. This was
its highest reading since early February.
Jose Rasco
Vice President, Senior Economist,
(1) 212-449-9107
Refer to important disclosures on page 29.
 The Market Economist – 6 August 2004

Debt Issuance

Table 1: Treasury Financing

(billions of $)
Announcement Date Auction Date Settlement Date Issue Size New Cash
Aug-5 Aug-9 Aug-12 3 & 6-Month 36.0 1.5
Aug-4 (Qtr. Refunding) Aug-9 Aug-16 3-Year Note 22.0 22.0
Aug-4 (Qtr. Refunding) Aug-11 Aug-16 5-Year Note 15.0 (0.4)
Aug-4 (Qtr. Refunding) Aug-12 Aug-16 10-Year Note 14.0 0.6
Aug-5 Aug-9 Aug-12 3 & 6-Month 36.0 1.5
Aug-9 Aug-10 Aug-12 1-Month 22.0* 0.0*
Aug-12 Aug-16 Aug-19 3 & 6 Month 36.0* 1.0*
Aug-23 Aug-25 Aug-31 2-Year Note 24.0* (2.7)*
* Estimate. ( ) = Paydown.

Table 2: Agency Financing

(billions of $)
Announcement Date Auction Date Settlement Dates Issue Size
Aug-5 Aug-9 Aug-10 FRE 1-Month 3.0
Aug-5 Aug-9 Aug-10 FRE 3-Month 3.0
Aug-5 Aug-10 Aug-11 FRE 6-Month 1.0
Aug-9 Aug-11 Aug-12 FNM 3-Month
Aug-9 Aug-11 Aug-12 FNM 6-Month
Aug-9 Aug-11 Aug-12 FNM 1-Year
Aug-9 Aug-12 TBA FNM Callable TBA
Aug-12 Aug-16 Aug-17 FRE 1-Month
Aug-12 Aug-16 Aug-17 FRE 3-Month
Aug-12 Aug-17* Aug-18 FRE 6-Month
Aug-13 Aug-18* Aug-20 FRE 2 or 3-Year
Aug-13 TBA TBA FRE 5 or 10 Year**
FRE = Freddie Mac, FNM = Fannie Mae * Pricing Date. **In 2004, Freddie Mac’s 5 or 10-year sales are optional.
TBA = To Be Announced.

Policy Speakers

Speaking Engagements & News Events

Mon N.A. President Bush will host Polish Prime Minister Marek Belka at the
White House.
N.A. Bank of Japan holds monetary policy meeting.
Tues 9:00 am Federal Open Market Committee will meet to decide key interest
rates, in Washington. Announcement expected around 2:15 p.m.
EDT.
Wed – Sun N.A. Japanese Financial Services Minister Heizo Takenaka will visit the
United States and will meet New York Fed President Timothy
Geithner in New York.
Thurs 1:15 pm Federal Reserve Governor Edward Gramlich will speak on Rules
for Assessing Social Security Reform to the Retirement Research
Consortium Conference at the National Press Club in Washington.
Q&A expected.
2:00 pm Federal Reserve will release minutes of June 29-30
FOMC meeting, in Washington.

Refer to important disclosures on page 29. 21

 The Market Economist – 6 August 2004

With Q2 earnings season 85%
done, operating EPS should
come in 30% higher than a year
ago.
20% EPS growth in the second
half of the year looks
reasonable.
However, earnings estimates for
2005 are coming down... and it
looks like there’s further
downside risk.
Q2 Earnings Update
The Q2 earnings season is nearly 85% done and by and large the results are
impressive. It looks like operating EPS will come in at about $16.80 (assuming
the remaining 85 companies surprise to the upside by the same margin), 30%
higher than year ago levels2 (note that S&P is actually looking for earnings to
come in at $16.90, up 31% year-over-year). All sectors are coming in ahead of
expectations, with the largest upside surprises in materials (beating estimates by
11 percentage points), utilities and consumer discretionary (beating estimates by 7
percentage points) (see Table 1). In the aggregate, earnings are coming in about
4.5% ahead of expectations, which is larger than the historical average (3%
surprise factor) but lower than the surprise factors of the prior five quarters.
In terms of guidance, earnings estimates for Q3 came down this week, largely due
to some downgrades in IT and consumer discretionary. The bottom up consensus
is now looking for 14.7% EPS growth, down from 15% last week. In our view,
this is not the start of a new trend. We believe earnings estimates will continue to
get ratcheted higher in the coming weeks. The revision ratios have been pretty
low by historical standards and according to First Call preannouncments are also
coming in below historical trends (Table 2). Q4 earnings expectations were left
unchanged. By the looks of things, 20% EPS growth in the second half of the year
is not out of the question.
Earnings estimates for 2005, on the other hand, continue to get ratcheted lower
(downgraded for an eighth week in a row). Consensus is now looking for 10.1%
EPS growth, which would represent a pretty sharp deceleration from the current
30% growth rates we’ve recently been enjoying (see Table 4 on the next page).
By our estimates, we think earnings estimates will most likely get ratcheted even
lower, especially in the consumer related sectors (for more please see Market
Economist July 16). In our view, operating earnings will rise only 3% next year.
Next week the market will have fewer Q2 earnings releases to digest. We have
outlined the key market movers in Table 5 on page 24.

Table 1: S&P 500 Q2 Earnings Results

Percent of Percent of Percent of
Co’s Co’s Co’s
If Rest of Reporting Reporting Reporting Median Net # of
Consensus Results to Forecasts Positive Positive YoY Above Income Companies
Sector EPS Estimate Date Materialize Earnings Comparisons Consensus Growth Reporting
S&P 500 20.6% 26.0% 25.3% 96.9% 83.4% 68.2% 20.3% 421
Consumer Discretionary 28.0% 39.3% 35.0% 98.5% 90.8% 72.3% 22.4% 65
Consumer Staples 8.0% 8.8% 8.9% 100.0% 84.6% 65.4% 11.0% 26
Energy 51.7% 53.3% 58.5% 95.5% 95.5% 81.8% 46.2% 22
Financials 10.7% 18.9% 15.3% 100.0% 85.3% 65.3% 14.8% 75
Health Care 11.8% 15.1% 14.0% 97.7% 74.4% 65.1% 21.6% 43
Industrials 21.5% 26.3% 27.1% 96.3% 83.3% 79.6% 23.9% 54
IT 57.7% 66.6% 62.8% 92.5% 89.6% 58.2% 71.8% 67
Materials 74.7% 85.8% 85.8% 93.9% 97.0% 66.7% 32.0% 33
Telecom -17.2% -7.8% -11.1% 90.0% 40.0% 90.0% -4.1% 10
Utilities 6.6% 7.3% 13.7% 100.0% 46.2% 57.7% -0.9% 26
Source: Merrill Lynch, First Call

2
Note that the S&P calculates earnings growth differently than First Call. S&P uses last year’s
constituents as its base, while First Call uses this year’s constituents. As a result, the S&P growth
rate tends to be larger than the First Call’s estimate.

22 Refer to important disclosures on page 29.

 The Market Economist – 6 August 2004

Table 2: S&P 500 Q3 Earnings Expectations

Downgrades/
01-Oct-03 01-Jan-04 01-Feb-04 01-Mar-04 01-Apr-04 01-May-04 01-Jun-04 01-Jul-04 30-Jul-04 Upgrades
Consumer Discretionary 17% 16% 18% 19% 23% 25% 25% 25% 22% 1.3
Consumer Staples 10% 8% 8% 8% 9% 10% 9% 9% 8% 2.3
Energy -11% -14% -13% -12% -7% -5% 7% 16% 22% 0.6
Financial 9% 5% 6% 7% 8% 8% 8% 11% 11% 1.1
Health Care 16% 12% 11% 11% 11% 10% 9% 9% 9% 1.1
Industrials 15% 14% 16% 15% 15% 16% 16% 16% 16% 0.4
Materials 57% 40% 46% 49% 51% 55% 57% 61% 67% 0.8
Technology 33% 28% 32% 33% 33% 35% 36% 38% 35% 0.8
Telecom 3% 1% 0% -6% -7% -10% -10% -13% -13% 0.7
Utilities 11% 7% 5% 5% 5% 3% 3% 4% 4% 0.0
S&P 500 12.8% 14.0% 10.7% 11.1% 12.0% 12.0% 13.0% 14.8% 14.7% 0.9
Source: Merrill Lynch, First Call, I/B/E/S. Downgrades/Upgrades ratio based on a trailing four-week basis aggregated from the bottom up.

Table 3: S&P 500 Q4 Earnings Expectations

Downgrades/
01-Jan-04 01-Feb-04 01-Mar-04 01-Apr-04 01-May-04 01-Jun-04 01-Jul-04 30-Jul-04 Upgrades
Consumer Discretionary 17% 16% 14% 16% 17% 17% 17% 17% 1.1
Consumer Staples 12% 10% 11% 10% 12% 12% 12% 11% 1.1
Energy -7% -11% -12% -5% -3% 7% 14% 20% 0.6
Financial 11% 11% 11% 13% 13% 13% 14% 13% 1.3
Health Care 18% 17% 17% 17% 17% 16% 16% 15% 1.1
Industrials 11% 13% 13% 13% 14% 15% 14% 15% 0.5
Materials 49% 47% 50% 51% 52% 53% 58% 68% 0.6
Technology 26% 18% 18% 18% 21% 22% 23% 20% 0.9
Telecom 13% 9% 7% 5% 0% 0% -3% -3% 0.9
Utilities 14% 8% 12% 14% 12% 9% 10% 11% 0.0
S&P 500 14.0% 12.5% 12.3% 13.0% 14.0% 15.0% 15.7% 15.6% 0.9
Source: Merrill Lynch, First Call.

Table 4: 2005 Operating EPS Estimates

Downgrades/
17-May-04 24-May-04 01-Jun-04 07-Jun-04 14-Jun-04 21-Jun-04 28-Jun-04 06-Jul-04 12-Jul-04 19-Jul-04 30-Jul-04 Upgrades
Consumer 15% 15% 15% 15% 15% 15% 15% 15% 15% 15% 14% 0.6
Discretionary
Consumer Staples 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 11% 0.8
Energy -10% -11% -12% -13% -14% -14% -14% -15% -16% -16% -16% 0.3
Financials 10% 10% 10% 10% 10% 10% 9% 10% 10% 10% 9% 0.7
Health Care 14% 13% 13% 13% 13% 13% 13% 13% 13% 13% 13% 0.8
Industrials 17% 16% 16% 16% 16% 17% 17% 17% 17% 17% 17% 0.2
Materials 25% 25% 25% 25% 25% 24% 24% 24% 24% 24% 24% 0.4
IT 19% 19% 19% 20% 20% 20% 20% 20% 19% 19% 17% 0.8
Telecom 2% 2% 2% 2% 3% 3% 2% 2% 2% 1% 1% 0.8
Utilities 7% 8% 8% 8% 8% 8% 8% 8% 8% 8% 9% N.M
S&P 500 11.2% 11.2% 11.0% 11.0% 10.9% 10.8% 10.7% 10.6% 10.5% 10.4% 10.1% 0.6
Source: Merrill Lynch, First Call.

Refer to important disclosures on page 29. 23

 The Market Economist – 6 August 2004

Table 5: Next Week’s Key Q2 Earnings Releases

Estimate Range
Reporting
Company Ticker Date ML EPS Consensus High Low 2Q03 Y/Y Sector Industry ML Analyst
Hewlett-Packard Co HPQ 08/09/2004 $0.30 $0.31 $0.33 $0.29 $0.29 6.9% Electronic Computer S. Milunovich
Technology Processing
Hardware
Cisco Systems Inc CSCO 08/10/2004 $0.20 $0.20 $0.21 $0.19 $0.15 33.3% Electronic Computer T. Liani
Technology Communications
Disney (Walt) Co DIS 08/10/2004 $0.27 $0.27 $0.30 $0.21 $0.11 140.9% Consumer Media J. Cohen
Services Conglomerates
Abercrombie & Fitch -Cl A ANF 08/10/2004 $0.41 $0.40 $0.43 $0.38 $0.26 55.0% Retail Trade Apparel/Footwear M. Friedman
Retail
Federated Dept Stores FD 08/11/2004 $0.66 $0.61 $0.72 $0.38 $0.24 153.8% Retail Trade Department Stores S. Turnof
Wal-Mart Stores WMT 08/12/2004 $0.61 $0.61 $0.62 $0.59 $0.41 47.6% Retail Trade Discount Stores D. Barry
Dell Inc DELL 08/12/2004 $0.31 $0.31 $0.31 $0.29 $0.23 34.3% Electronic Computer S. Milunovich
Technology Processing
Hardware
Target Corp TGT 08/12/2004 $0.46 $0.47 $0.47 $0.45 $0.38 22.9% Retail Trade Discount Stores D. Barry
Penney (J C) Co JCP 08/12/2004 $0.23 $0.22 $0.24 $0.13 $0.20 10.5% Retail Trade Department Stores D. Barry
May Department Stores Co MAY 08/12/2004 $0.36 $0.35 $0.40 $0.32 $0.13 172.3% Retail Trade Department Stores S. Turnof
Tiffany & Co TIF 08/13/2004 $0.30 $0.29 $0.31 $0.28 $0.24 22.1% Retail Trade Specialty Stores M. Friedman
Ann Taylor Stores Corp ANN 08/13/2004 $0.41 $0.40 $0.44 $0.39 $0.26 55.0% Retail Trade Apparel/Footwear M. Friedman
Retail
Source: Merrill Lynch, First Call.

24 Refer to important disclosures on page 29.

 The Market Economist – 6 August 2004

Historical Economic Data

2004 2003
Jul Jun May Apr Mar Feb Jan Dec Nov Oct Sept Aug Jul
Payroll Employment (000) 32 78 208 324 353 83 159 8 83 88 67 -25 -45
% Change, Year Ago 1.1 1.1 1.0 0.8 0.5 0.2 0.0 0.0 -0.2 -0.3 -0.3 -0.4 -0.4
Unemployment Rate (%) 5.5 5.6 5.6 5.6 5.7 5.6 5.6 5.7 5.9 6.0 6.1 6.1 6.2
Avg. Hourly Earnings 0.3 0.1 0.3 0.3 0.2 0.2 0.3 -0.1 0.2 0.1 0.0 0.1 0.4
(% Chg.)
% Change, Year Ago 1.9 2.0 2.1 2.2 1.8 1.6 2.0 1.8 2.2 2.2 2.4 2.7 2.9
PPI (% Chg.) -0.3 0.8 0.7 0.5 0.1 0.6 0.2 -0.1 0.6 0.2 0.5 0.1
% Change, Year Ago 4.0 4.9 3.6 1.4 2.1 3.3 3.9 3.4 3.4 3.5 3.5 3.0
CPI (% Chg.) 0.3 0.6 0.2 0.5 0.3 0.5 0.2 -0.2 -0.1 0.3 0.4 0.2
% Change, Year Ago 3.2 3.0 2.3 1.7 1.7 2.0 1.8 1.8 2.0 2.3 2.2 2.1
ISM Diffusion Index (%) 62.0 61.1 62.8 62.4 62.5 61.4 63.6 63.4 61.3 57.1 54.7 55.0 52.6
Industrial Production -0.3 0.9 0.8 -0.1 0.8 0.6 0.2 1.0 0.3 0.6 0.0 0.8
(% Chg.)
% Change, Year Ago 5.6 5.9 4.9 3.5 2.8 2.4 2.3 1.5 0.7 0.1 -0.6 -0.6
Capacity Utilization, (%) 77.2 77.6 77.0 76.6 76.7 76.2 75.8 75.7 75.0 74.9 74.5 74.5
Durable Goods Orders 0.7 -0.9 -2.7 5.9 3.9 -2.6 1.7 -2.4 3.9 2.2 -0.1 1.6
(% Chg.)
% Change, Year Ago 11.3 13.2 14.3 15.9 10.3 5.7 10.7 7.4 8.9 7.7 -1.0 -1.4
Factory Orders (% Chg.) 0.7 0.4 -1.1 5.0 1.1 -0.9 1.8 -0.9 2.4 1.4 -0.3 2.0
% Change, Year Ago 12.1 13.3 13.3 11.5 7.8 6.1 8.8 6.6 6.8 6.4 1.7 1.9
Retail Sales (% Chg.) -1.1 1.4 -0.8 2.1 1.0 0.5 0.2 1.2 0.2 -0.5 1.1 1.0
% Change, Year Ago 6.3 9.2 7.5 8.6 8.5 6.3 6.4 7.3 6.6 7.0 6.1 5.3
Personal Consumption -0.7 1.0 0.1 0.4 0.6 0.6 0.6 0.8 0.2 -0.2 1.0 0.6
(% Chg.)
% Change, Year Ago 5.3 6.6 5.7 5.8 6.1 5.9 5.2 5.8 5.6 5.8 5.6 4.5
Personal Income (% Chg.) 0.2 0.6 0.6 0.5 0.5 0.5 0.4 0.7 0.4 0.4 0.4 0.3
% Change, Year Ago 5.4 5.7 5.7 5.2 5.2 5.1 4.9 4.7 4.2 3.9 3.5 3.1
New Home Sales 1326 1337 1197 1270 1165 1155 1120 1086 1141 1127 1189 1156
(SAAR, Thous.)
% Change, Year Ago 11.1 22.3 16.6 26.2 25.0 15.4 6.9 6.1 13.4 8.0 17.3 20.9
Existing Home Sales 6950 6810 6630 6480 6130 6000 6370 6130 6390 6680 6390 6190
(SAAR, Thous.)
% Change, Year Ago 17.4 15.0 13.3 17.2 4.6 -1.6 7.8 8.9 10.6 22.8 19.2 14.6
Housing Starts (SAAR, Thous) 1802 1970 1963 2000 1895 1934 2067 2054 1983 1922 1835 1893
% Change, Year Ago -2.6 12.7 19.9 15.7 14.4 4.2 15.6 17.2 20.3 6.5 12.4 14.4
International Trade (Bil $) -46.0 -48.1 -46.6 -45.2 -45.2 -44.0 -40.0 -41.5 -41.3 -40.2 -40.8
Consumer Conf. Conf. Board 106.1 102.8 93.1 93.0 88.5 88.5 97.7 94.8 92.5 81.7 77.0 81.7 77.0
Consumer Conf. U. of Mich. 96.7 95.6 90.2 94.2 95.8 94.4 103.8 92.6 93.7 89.6 87.7 89.3 90.9

04Q2 04Q1 03Q4 03Q3 03Q2 03Q1 02Q4 02Q3 02Q2 02Q1 01Q4 01Q3 01Q2
Real GDP, Chain-Weighted, 3.0 4.5 4.2 7.4 4.1 1.9 0.7 2.6 2.4 3.4 1.6 0.2 -0.6
SAAR
% Change, Year Ago 4.8 5.0 4.4 3.5 2.3 1.9 2.3 2.5 1.9 1.1 0.2 0.4 0.2
Chain-Weighted Price Index, 3.2 2.7 1.4 1.3 1.1 2.9 2.0 1.3 1.8 1.0 2.0 1.7 3.1
SAAR
% Change, Year Ago 2.2 1.7 1.7 1.8 1.8 2.0 1.5 1.5 1.6 1.9 2.5 2.4 2.5
Nominal GDP, SAAR 6.3 7.4 5.7 8.8 5.3 4.9 2.7 3.9 4.2 4.4 3.6 0.2 4.4
% Change, Year Ago 7.0 6.8 6.2 5.4 4.2 3.9 3.8 4.1 3.1 3.2 2.7 2.8 3.1
Employment Cost Index, % 0.9 1.1 0.8 1.0 0.9 1.2 0.9 0.8 1.0 0.9 1.0 1.0 1.0
% Change, Year Ago 3.9 3.8 3.9 4.0 3.8 3.9 3.6 3.7 4.0 3.9 4.1 4.0 4.0
Productivity, Nonfarm, SAAR 3.8 2.5 9.5 6.2 3.4 2.3 4.5 0.7 9.8 7.0 1.6 3.1
% Change, Year Ago 5.4 5.4 5.3 4.2 2.8 4.3 5.4 4.7 5.3 2.9 2.0 1.5
Unit Labor Costs, Nonfarm, 0.8 1.7 -4.3 -1.3 0.6 -0.1 -3.1 1.6 -7.8 -2.8 1.3 -0.7
SAAR
% Change, Year Ago -0.8 -0.9 -1.2 -1.0 -0.3 -2.5 -3.1 -2.0 -2.5 0.9 1.2 3.1

Refer to important disclosures on page 29. 25

 The Market Economist – 6 August 2004

Merrill Lynch Economic Forecast Summary

(As of August 6, 2004)

2004.1A 2004.2A 2004.3F 2004.4F 2005.1F 2005.2F 2005.3F 2005.4F 2003A 2004F 2005F
Real Economic Activity, % SAAR
Real GDP 4.5 3.0 3.0 3.5 2.5 3.3 3.0 2.8 3.0 4.2 3.0
% Change, Year Ago 5.0 4.8 3.7 3.5 3.0 3.1 3.1 2.9
Final Sales 3.3 2.8 3.0 3.9 2.6 3.7 3.2 3.0 3.1 3.8 3.2
Domestic Demand 3.9 2.7 2.9 3.6 2.4 3.5 2.9 2.7 3.4 3.9 3.0
Consumer Spending 4.1 1.0 2.3 2.8 2.5 3.3 2.5 2.4 3.3 3.2 2.6
Durables 2.2 -2.5 4.5 3.0 2.5 4.0 2.5 2.2 7.4 4.6 2.8
Nondurables 6.7 -0.1 2.0 3.0 3.0 3.5 2.4 2.3 3.7 4.0 2.7
Services 3.3 2.3 2.0 2.6 2.3 3.0 2.6 2.5 2.2 2.6 2.5
Residential Investment 5.0 15.4 4.0 2.5 1.0 4.0 3.5 3.0 8.7 9.7 3.5
Nonresidential Investment 4.2 8.8 7.0 11.7 3.5 7.1 6.0 6.0 3.3 9.0 6.9
Structures -7.6 5.2 5.0 4.0 2.0 4.0 2.5 2.5 -5.6 1.9 3.4
Equipment and Software 8.0 10.0 7.5 14.0 4.0 8.0 7.0 7.0 6.4 11.2 7.9
Government 2.5 2.3 2.5 2.5 1.5 2.5 2.4 2.0 2.8 2.3 2.2
Exports 7.3 13.2 5.0 6.0 7.0 7.0 8.0 7.0 1.9 9.7 7.1
Imports 10.6 9.3 3.5 3.3 3.9 4.9 4.7 3.9 4.4 8.6 4.3
Net Exports (billions of $) -550.1 -552.8 -553.5 -550.6 -547.1 -547.6 -544.4 -540.4 -518.5 -551.8 -544.9
Inventory Accumulation(billions of $) 40.0 47.5 46.0 38.0 35.0 25.0 22.0 18.0 -0.7 42.9 25.0

Nominal GDP (billions of $) 11,473 11,649 11,814 11,989 12,120 12,279 12,427 12,576 11,004 11,731 12,350
% SAAR 7.4 6.3 5.8 6.1 4.4 5.3 4.9 4.9 4.9 6.6 5.3
% Change, Year Ago 6.8 7.0 6.3 6.4 5.6 5.4 5.2 4.9
Key Indicators
Industrial Production, FRB, % SAAR 6.6 6.0 4.3 4.8 2.3 4.0 3.8 4.0 0.3 4.9 3.9
Capacity Utilization (percent) 76.5 77.3 77.7 78.2 78.4 78.8 79.1 79.3 74.8 77.4 78.9
Civilian Unemployment Rate (%) 5.6 5.6 5.6 5.5 5.7 5.6 5.6 5.6 6.0 5.6 5.6
Productivity, % SAAR 3.8 2.0 2.6 3.0 1.9 2.8 2.6 2.2 4.4 3.8 2.4
% Change, Year Ago 5.4 4.4 2.7 2.8 2.3 2.5 2.5 2.3
Real Disp. Personal Inc. % SAAR 3.2 2.9 3.4 4.0 2.2 3.2 3.2 2.8 2.3 3.6 3.1
% Change, Year Ago 4.2 3.9 2.7 3.4 3.1 3.2 3.1 2.8
Personal Savings Rate (%) 1.2 1.7 2.0 2.2 2.4 2.5 2.6 2.7 1.3 1.8 2.6
Light Vehicle Sales (Millions SAAR) 16.5 16.5 16.8 16.4 15.8 16.2 15.8 15.4 16.6 16.6 15.8
Housing Starts (Millions SAAR) 1.94 1.91 1.88 1.85 1.83 1.88 1.83 1.80 1.85 1.90 1.84
U.S. Budget Balance (billions of $ FY) -374 -450 -385
Corporate Profits and Earnings
Operating Corp. Profits After Tax (Bil $) 909.2 983.8 957.5 1034.6 953.0 1042.5 1010.1 1081.6 786.2 971.3 1021.8
% Change, Year Ago 32.1 29.2 17.0 18.0 4.8 6.0 5.5 4.5 13.8 23.5 5.2
S&P 500 Earnings Per Share ($)* 15.18 16.14 15.75 16.00 14.95 15.80 15.80 16.20 48.73 63.07 62.75
% Change, Year Ago 27.5 45.4 25.4 21.6 -1.5 -2.1 0.3 1.3 76.6 29.4 -0.5
S&P 500 Operating EPS ($) 15.87 16.88 16.50 17.50 16.20 17.30 17.30 18.20 54.69 66.75 69.00
% Change, Year Ago 27.2 30.7 14.5 17.6 2.1 2.5 4.8 4.0 18.8 22.1 3.4
Inflation
GDP Price Index, % SAAR 2.8 3.2 2.4 2.4 1.9 2.0 1.8 2.0 1.8 2.3 2.2
% Change, Year Ago 1.7 2.3 2.5 2.7 2.5 2.2 2.0 1.9
CPI, Consumer Prices, % SAAR 3.6 4.7 3.0 2.9 2.0 2.0 1.8 1.7 2.3 2.8 2.4
% Change, Year Ago 1.8 2.8 3.0 3.6 3.2 2.5 2.2 1.9
CPI Ex Food & Energy, % SAAR 1.8 3.0 3.3 1.2 1.3 2.2 1.7 1.7 1.6 1.9 1.9
% Change, Year Ago 1.3 1.8 2.3 2.3 2.2 2.0 1.6 1.7
International Trade and the Dollar
Current Account (billions of $) -144.9 -148.4 -150.9 -149.9 -149.0 -149.3 -147.9 -146.0 -530.8 -594.0 -592.0
Shaded regions represent Merrill Lynch forecasts * 2005 reported EPS includes the impact of stock options expensing.

26 Refer to important disclosures on page 29.

 The Market Economist – 6 August 2004

ML Financial Market Forecast

Table 1: Interest Rate Forecast
Quarters Years
Percent, End of Period 2004:3 2004:4 2005:1 2005:2 2005:3 2005:4 2004 2005
Fed Funds 1.75 2.00 2.50 2.50 2.50 2.50 2.00 2.50
3-Month T-Bill 2.00 2.25 2.65 2.55 2.50 2.50 2.25 2.50
3-Month LIBOR 2.00 2.35 2.75 2.70 2.65 2.65 2.35 2.65
2-Year T-Note 3.00 3.25 3.45 3.00 2.90 2.85 3.25 2.85
5-Year T-Note 4.05 4.35 4.40 3.90 3.75 3.65 4.35 3.65
10-Year T-Note 4.75 5.00 4.90 4.65 4.30 4.15 5.00 4.15
30-Year T-Bond 5.40 5.55 5.65 5.40 5.10 4.95 5.55 4.95

Real GDP (annualized) 3.0 3.5 2.5 3.3 3.0 2.8 4.2* 3.0*
Core CPI (Year/Year) 2.2 2.2 2.1 1.9 1.6 1.9 1.9* 1.9*
Budget Balance ($ Bil. **) -450 -385
Current Account ($ Bil.***) -592 -595
Source: Merrill Lynch
* Annual Average % Change **Cumulative Balance on a Fiscal Year Basis ***Cumulative Balance on a Annual Basis

Table 2: Global Exchange Rate Forecasts

(Last Month of the Quarter) (Forecast as of August 4, 2004. Current Spot as of Thursday’s close)
Current
Spot Sept-2004 Dec-2004 Mar-05 Jun-05 Sep-05 Dec-05
Euroland Euro US$/Euro 1.21 1.25 1.29 1.33 1.37 1.36 1.34
Japanese Yen ¥/US$ 111.79 110.00 107.00 100.00 95.00 92.00 95.00
¥/Euro 134.77 138.00 138.00 133.00 130.00 125.00 127.00
British Pound US$/£ 1.82 1.87 1.84 1.82 1.85 1.79 1.72
£/Euro 0.66 0.67 0.70 0.73 0.74 0.76 0.78
Swiss Franc SF/US$ 1.28 1.23 1.19 1.14 1.09 1.13 1.15
SF/Euro 1.54 1.54 1.53 1.51 1.50 1.53 1.54
Canadian $ C$/US$ 1.32 1.29 1.26 1.24 1.20 1.22 1.23
¥/C$ 84.83 79.72 85.27 85.07 80.90 79.17 75.41
Australian $ US$/A$ 0.70 0.73 0.68 0.66 0.66 0.66 0.66
¥/A$ 78.63 81.00 79.94 72.65 66.01 62.70 60.72`
Chinese Renminbi RMB/US$ 8.28 8.28 7.50 7.45 7.23 7.31 7.38
Hong Kong $ HK$/US$ 7.80 7.79 7.74 7.74 7.75 7.77 7.78
Korean Won KRW/US$ 1164 1170 1080 1050 1030 1020 1050
Singapore $ SGD/US$ 1.72 1.71 1.67 1.65 1.64 1.58 1.58
Taiwan $ TWD/US$ 34.16 35.00 33.00 32.00 31.00 30.00 31.00
Thai Baht THB/US$ 41.46 42.00 40.00 40.00 39.00 38.00 39.00
Brazilian Real BRL/US$ 3.07 3.15 3.20 3.25 3.30 3.40 3.40
Mexican Peso MXN/US$ 11.43 11.40 11.10 11.00 11.30 11.50 11.20
Source: Merrill Lynch FX Strategy Team.

Table 3: West Texas Intermediate Forecasts ($/BBL) (As of June 30, 2004)
AQ1-04 AQ2-04 Q3-04 Q4-04 FY04 FY05 FY06 FY07 FY08
WTI * $35.33 $38.33 $32.00 $32.00 $34.40 $28.00 $28.00 $28.00 $28.00
*Prices shown for 3Q ’04 and beyond are the values incorporated into earnings/cash flow models by the Energy Team
Source: Merrill Lynch Energy Team

Refer to important disclosures on page 29. 27

 The Market Economist – 6 August 2004

Rolling Calendar of Business Indicators

MONDAY TUESDAY WEDNESDAY THURSDAY FRIDAY

Aug 9 Aug 10 Aug 11 Aug 12 Aug 13
Wholesale Inventories Productivity Mortgage Banker’s Initial Unemployment Producer Price Index
Apr............................................ 0.2% 03Q4 ........................................ 2.5% Survey(week ending 8/06/04) Claims(week ending 8/07/04) May...........................................0.8%
May .......................................... 1.2% 04Q1 ........................................ 3.8% Treasury Statement 340,000* Jun.......................................... -0.3%
June ......................................... 0.5%* 04Q2 (Prel.) ............................. 2.0%* July ‘03 ...............................-$54.2B Retail Sales Jul.............................................0.2%*
3-Year Note Auction $22.0B Unit Labor Costs July ‘04 ...............................-$61.0B* May .......................................... 1.4% Core PPI
03Q4 ........................................ 1.7% 5-Year Note Auction$15.0B Jun .......................................... -1.1% May...........................................0.3%
04Q1 ........................................ 0.8% Jul ............................................ 0.8%* Jun............................................0.2%
04Q2 (Prel.) ............................. 2.5%* Retail Sales Ex. Autos Jul.............................................0.1%*
Richmond FRB IndexJuly May .......................................... 0.9% International Trade
LJR Redbook(week ending Jun .......................................... -0.2% Apr ...................................... -$48.1B
8/07/04) Jul ............................................ 0.2%* May..................................... -$46.0B
ABC/Money Magazine Consumer Import Prices June.................................... -$46.4B*
Survey(week ending 8/08/04) May .......................................... 1.4% Consumer Sentiment (Univ. of
FOMC Meeting Jun .......................................... -0.2% Mich.)
Jul ............................................ 0.4%* Jun..........................................95.6
Export PricesJuly Jul...........................................96.7
May .......................................... 0.4% Aug (Prel.) ..............................98.0*
Jun .......................................... -0.6%
Business Inventories
Apr ........................................... 0.7%
May .......................................... 0.4%
June ......................................... 0.6%*
FOMC Minutes––6/29-30/04
10-Year Note Auction$14.0B
Aug 16 Aug 17 Aug 18 Aug 19 Aug 20
NY Fed Empire State Mfg. CPI Mortgage Banker’s Initial Unemployment Retail E-Commerce04Q2
Index)August May .......................................... 0.6% Survey(week ending 8/13/04) Claims(week ending 8/14/04)
Jun ......................................... 29.93 June ......................................... 0.3% Leading IndicatorsJuly
July......................................... 36.54 July........................................... 0.2% May .......................................... 0.4%
NAHB (Housing Index)August Core CPI June ........................................ -0.2%
July......................................... 67 May .......................................... 0.2% Philadelphia Fed Mfg.
Treasury Int’l Capital June ......................................... 0.1% SurveyAugust
SystemJune July........................................... 0.1% June ....................................... 28.9%
Housing StartsJuly July ........................................ 36.10
May .......................................... 1.97M
June ......................................... 1.80M
Housing PermitsJuly
May .......................................... 2.10M
June ......................................... 1.94M
Industrial Production
May .......................................... 0.9%
June ........................................-0.3%
July........................................... 0.7%
Capacity Utilization
May ........................................ 77.6%
June ....................................... 77.2%
July......................................... 77.6%
Real EarningsJuly
LJR Redbook(week ending
8/14/04)
ABC/Money Magazine Consumer
Survey(week ending 8/15/04)

Aug 23 Aug 24 Aug 25 Aug 26 Aug 27

2-Year Note Existing Home SalesJuly Durable Goods OrdersJuly Initial Unemployment Gross Domestic Product
Announcement$24.0B* May .......................................... 6.81M May .........................................-1.0% Claims(week ending 8/21/04) 04Q2 (Preliminary)
June ......................................... 6.95M June .........................................0.9% Help Wanted Index––––July 03Q4.........................................4.5%
LJR Redbook(week ending New Home SalesJuly May ........................................ 39 04Q1.........................................3.0%
8/21/04) May ..........................................1.34M June ....................................... 38 Univ. of Michigan (Consumer
ABC/Money Magazine Consumer June .........................................1.33M SentimentAugust
Survey(week ending 8/22/04) Mortgage Banker’s Jun..........................................95.6
Survey(week ending 8/20/04) Jul...........................................96.7

2-Year Note Auction$24.0B*

*Projections—subject to revision as additional data become available during the month

28 Refer to important disclosures on page 29.

 The Market Economist – 6 August 2004

Important Disclosures

Copyright 2004 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). All rights reserved. Any unauthorized use or disclosure is prohibited. This report has been
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This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives,
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investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be
realized. Investors should note that income from such securities, if any, may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may
receive back less than originally invested. Past performance is not necessarily a guide to future performance.
Neither the information nor any opinion expressed constitutes an offer to buy or sell any securities or options or futures contracts.
Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in
securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk.

Refer to important disclosures on page 29. 29