From: US GIO To: Undisclosed recipients:; Subject: Eye on the Market, November 4, 2010 Date: Thu, 04 Nov 2010 17:29:20 +0000 Inline-Images: image001.png; image002.png; image003.png; image004.png; image005.jpg; image006.png; image007.png Eye on the Market, November 4, 2010 Topics: The most surprising news of the week: was it S&P profits, QE2, commodities or the elections? And Weimar, revisited While QE2 and election results have been well telegraphed for weeks, strength of profits and margins in the face of weak growth continues to surprise. As shown in the first chart, U.S. companies are generating strong profits growth at a time of weak GDP growth (red dots). When growth is this weak, profits are often declining. Furthermore, margins continue to hover around historical peaks. Rising commodity prices may hurt some sectors (e.g., apparel, electrical equipment, low-margin consumer staples, furniture, machinery, airlines, waste management), but in aggregate, energy and industrial commodities only represent 7% of total corporate input costs for the median industry. A lot will depend on the balance between rising commodity prices and rising demand. Proft growth outpacing GDP growth WSW profit - YoY 50% 30% 10% .10% -30% -50% -70% -5% 0% 5% 10% 15% 20% Source: BofA Merri Lynch Global Research. Bureau o f Economic Analysis. • • •• • • • • • a . • • 1978-2010 • Nominal GDP growth -YoY Profit margins near historical highs S&P500 Net Operating Margin 10% 2010 full year estimate 9%- • 8% - S&P 500 7% - 6% - UP Industrials 5% 4% - 3% - 29' 1979 1984 1988 1992 1996 2000 2004 2009 Sour e:BolAMerrill Lynch Global Research, Goldman Sachs. These profit results reflect stronger demand outside the U.S. where 30% of S&P revenues are earned, and aggressive steps taken to control supplier and inventory costs. But there are Achilles heels in these results as well. Declines in labor costs account for a lot of the margin