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Economy + Internet Trends
                                                                         March 20, 2009


      ...
Economy + Internet Trends Outline
•   Economy
    1. Recession – a long time coming, how long will it last?
    2. Adverti...
Economy


                            Recession =

               Long time coming, how long will it last?
         Ten ye...
10 Years Ago –
I Don’t Want to Miss a Thing, Aerosmith = Billboard Top 5 Song of 1998




                                ...
Roots of Economic Challenge?
10+ Years of Rising Home Ownership + Declining Interest / Savings Rates

                    ...
Market & Regulatory Pressure Made Home Buying
            More Accessible…1998

  In addition to a buoyant economy, the ov...
10 Years of Rising Home Prices –
                                                    Up ~2x at Peak
                      ...
Systemic Leverage Helped Pace ‘Easy Money’
                Debt at Record Level + Sharp Ramp Up in Foreign Ownership of US...
Excessive Debt Levels = 2008 & 1933
                                           Corporate Debt Much Lower on Relative Basis...
USA Debt Mix Shift –
  Mortgages / ABS / GSE Up to 23% of Debt vs. 7% 2 ½ Decades Ago

                 1984              ...
USA Mortgage Delinquency @ Record High 7.88%

                                        USA Residential Mortgage Delinquency...
Unemployment Benefits At 38-Year High and Rising

                                                          U.S. Unemploym...
Michigan Unemployment @ 11.6%, Up Nearly 2x Y/Y
                             USA @ 7.6%, On Way to California Level of 10....
Rising Unemployment                                  Higher Mortgage Defaults…

                                          ...
…Higher Unemployment / Mortgage Defaults
               Rising Personal Bankruptcy Filings…
               U.S. Weekly Per...
… Consumer Confidence Falling

               Overall Consumer Spending Survey Results – 6/06 - 2/09

  Would you say your...
Average Consumer Wealth Destruction = ~25% Through CQ4:08 –
     56%+ of USA Household Assets in Real Estate + Stocks


 U...
Difficult Retail Environment

                                              Abercrombie & Fitch Same-Store Sales          ...
Retail Sales + e-Commerce Growth Rates Slowing

                                      Adjusted Retail Sales vs. Adjusted E...
Corporate Sales –
             Increasingly Below Plan Since CQ1:06
           Overall Corporate Sales Survey Results, CQ1...
Material Revenue Growth Declines – TMT Companies
                              Intel + Nokia = Accelerating -20%+ Declines...
Technology Revenue – So far, a 2001 Redux of 5 Flat / Down Sequential
                         Quarters…Now 4…This Time, S...
USA Manufacturing Contracting Rapidly –
                       12/08 PMI Index Lowest Level Since 1980, 2/09 PMI = 35.8
  ...
-6.2% Q/Q USA GDP Growth in CQ4 / Consumer Spending Fell 4.3%
                        Biggest Q/Q Decline in GDP / PCE Sin...
Global GDP Growth Forecasts =
              Continued Trend of Downward Revisions
                                        ...
Stock Markets Stabilizing = Leading Indicator of Economic Growth
Russia off 74% vs. 36-Month Peak, Oil -67% / China -63% /...
S&P500 –
                      Key Spending Sectors Have Taken Big Hits

                         Total Mkt               ...
S&P500 Down 39% in 2008, 2nd Worst in 183 Year History –
                                        Bad Years Often Follow Go...
Current USA Bear Market – 3rd Worst in History
               Duration Still Relatively Short
           S&P 500
        P...
5 Weeks in History – Financial Services Restructuring
                                              (~$3T in US Aggregate ...
Credit Spreads @ 100-Year Extreme –
Current Level Down From 12/08 Peak, But Still 250bps+ Higher Than Post-Depression Peak...
Stock Market Volatility Implies High Uncertainty –
                            VIX Index Down From All-Time High But Still...
When Does Vicious Cycle End?
                      More Often Than Not, Peak Unemployment = Good Time to Invest
          ...
Sequencing the Asset Recovery Process –
High Quality Financials / USA Non-Cyclicals / IG Super Senior Should Lead the Way
...
Advertising Spending & GDP Growth =
                                                        High Correlation of 81%
      ...
Simple Regression Analysis:
                                     1) Ad spend growth 3x sensitivity of real GDP growth
    ...
Online Ad Spending Bad News =
                                           From 2000 to 2002, USA Spending Fell 27%

       ...
Online Ad Spending Good News = Now, Less Ad ‘Over Spending’ vs.
                                                   Trend L...
Technology / Internet




                        1) Digital Consumer –
Our bet = At margin, consumers spend more – not le...
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  1. 1. Economy + Internet Trends March 20, 2009 mary.meeker@ms.com / collis.boyce@ms.com / mayuresh.masurekar@ms.com / liang.wu@ms.com Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision. Customers of Morgan Stanley in the US can receive independent, third-party research on companies covered in Morgan Stanley Research, at no cost to them, where such research is available. Customers can access this independent research at www.morganstanley.com/equityresearch or can call 1-800-624-2063 to request a copy of this research. For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report.
  2. 2. Economy + Internet Trends Outline • Economy 1. Recession – a long time coming, how long will it last? 2. Advertising Spending – closely tied to GDP growth • Technology / Internet 1. Digital Consumer – Undermonetized social networks / video / VoIP driving powerful usage growth + material disruptions for traditional players that may accelerate in recession 2. Mobile – Innovation in wireless products / services accelerating 3. Emerging Markets – Pacing next wave of technology adoption 4. Cloud Computing – Access / storage need / virtualization driving change • Closing Thoughts 1. Companies with cogent business models that provide consumer value should survive / thrive – consumers need value more than they have needed it in a long time… 2
  3. 3. Economy Recession = Long time coming, how long will it last? Ten years of inflated growth to be followed by ____? Hope for six more tough months but plan for 3-5 years Advertising Spending = Closely tied to GDP growth. Challenges for Internet but likely not as draconian as 2000-2002 Commerce = Slowing but Amazon.com + iTunes data illustrate material online share gains from offline, recession / mobile should accelerate share gains 3
  4. 4. 10 Years Ago – I Don’t Want to Miss a Thing, Aerosmith = Billboard Top 5 Song of 1998 Source: YouTube. 4
  5. 5. Roots of Economic Challenge? 10+ Years of Rising Home Ownership + Declining Interest / Savings Rates USA Homeownership Rates vs. Interest Rates vs. Personal Savings Rates, 1965-2008 70% June 2004: US home ownership = 73MM 20% 68% 16% U.S. Interest Rate & Personal Savings Rate January 1993: HUD began promoting broader home ownership. US home U.S. Home Ownership Rate 66% ownership = 62MM 12% 64% 8% 62% 4% 60% 58% 0% 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 U.S. Home Ownership Rate U.S. Interest Rate U.S. Home Ownership Rate 30-year (1965-1995) Trendline U.S. Personal Savings Rate Note: HUD is Department of Housing & Urban Development. Interest rate is the overnight federal funds rate. All data as of 12/31/08. 5 Source: Federal Reserve, DOC Bureau of Economic Analysis (BEA), Morgan Stanley Research.
  6. 6. Market & Regulatory Pressure Made Home Buying More Accessible…1998 In addition to a buoyant economy, the overall housing industry owes its enduring vigor to innovations in mortgage finance that have helped not only expand homeownership opportunities, but also reduce market volatility. Under market and regulatory pressure to make home buying more accessible to low-income and minority households, financial institutions have revised their underwriting practices to make lending standards more flexible. In the process, they have developed several new products to enable more income- constrained and cash-strapped borrowers at the margin to qualify for mortgage loans. - 1998 State of the Nation’s Housing Report Note: Quoted in Gary Gorton’s NBER Working Paper Series “The Panic of 2007” (Working Paper 14358), p.5. Source: Harvard University, Joint Center for Housing Studies, 1998. 6
  7. 7. 10 Years of Rising Home Prices – Up ~2x at Peak USA Real Home Price & Building Cost Indexes, % Change 1965 - 2008 80% % Change From 1965 Level 60% 40% 20% 0% -20% 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 U.S. Real Home Price Index U.S. Real Building Cost Index Note: Real home prices & building costs are adjusted for inflation; Source: Robert Shiller. 7
  8. 8. Systemic Leverage Helped Pace ‘Easy Money’ Debt at Record Level + Sharp Ramp Up in Foreign Ownership of US Treasuries 400% U.S. Total Credit Market Debt as % of GDP 70% & Foreign Ownership % of U.S. Treasuries, 2008: 3.6x GDP 1920 - 2008 60% 350% Foreign Ownership of U.S. Treasuries, 1933: 3.0x GDP 50% Total Debt as % of GDP % of Total Market Cap 300% 40% 250% 30% 200% 20% 150% 10% 100% 0% 1920 1928 1936 1944 1952 1960 1968 1976 1984 1992 2000 2008 U.S. Total Debt, % of GDP Foreign Ownership of US Treasuries, % of Total Market Capitalization Note: Foreign ownership of US treasuries data N/A before 1965. Source: Federal Reserve, Ben Wattenberg, The Statistical History of the United States, From Colonial Times to the Present, Bridgewater, Morgan Stanley Research. 8
  9. 9. Excessive Debt Levels = 2008 & 1933 Corporate Debt Much Lower on Relative Basis Now U.S. Total Credit Market Debt as % of GDP, 1929 – 2008 & Sector Share Breakdown 350% 1984 - 2008 % Share of Total Debt Net Increase 1933 2008 Amount ($T) 300% Government + GSE 24% 33% $14.4 U.S. Credit Market Debt / GDP (%) Households 18 27 11.9 250% Corporates 51 22 8.8 GSE Financials 7 18 8.5 200% Financials 150% Government 100% Corporates 50% Households 0% 1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 Households Corporates Financials GSE Government Note: GSE (Government Sponsored Enterprises) debt includes various agency-backed mortgages; Source: Federal Reserve, Ben Wattenberg, The Statistical History of the United States, From Colonial Times to the Present, Morgan Stanley Research. 9
  10. 10. USA Debt Mix Shift – Mortgages / ABS / GSE Up to 23% of Debt vs. 7% 2 ½ Decades Ago 1984 2008 U.S. Total Debt: $7T U.S. Total Debt: $53T Total Mortgage / ABS / GSE Debt: $0.5T Total Mortgage / ABS / GSE Debt: $12T Mortgage Pools 9% ABS Issuers 8% Mortgage Pools – 4% Other ABS Issuers – 0% 20% Other – 22% GSE – 3% GSE 6% Household 26% Government 16% Government 25% Corporate Household 19% 27% Corporate 14% Note: Debt amounts are nominal, ABS is Asset Backed Security, GSE is Government Sponsored Enterprise. Source: Federal Reserve, Morgan Stanley Research. 10
  11. 11. USA Mortgage Delinquency @ Record High 7.88% USA Residential Mortgage Delinquency Rates, CQ1:98 – CQ4:08 20% Delinquency Rates (%) 15% 10% 5% 0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 All U.S. Mortgages Prime Mortgages Subprime Mortgages Note: National delinquency rate of 7.88% and Q/Q jump of 89 basis points in CQ4:08 are the highest since CQ1:1972, when data first became available; Average national mortgage delinquency rate from 1972-2007 is 4.70%; 11 Source: Mortgage Bankers Association.
  12. 12. Unemployment Benefits At 38-Year High and Rising U.S. Unemployment Rates & Total Benefits Paid, 1971 - 2009 $6,000 12% $5,000 10% Real Benefits Paid ($MM) Unemployment Rates $4,000 8% $3,000 6% $2,000 4% $1,000 2% $0 0% 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Real Benefits Paid Unemployment Rate Note: Unemployment Insurance : Benefits Paid Through State Programs are inflation adjusted, but not seasonally adjusted, while Civilian Unemployment Rates (16 yr+) are seasonally adjusted. Source: Bureau of Labor Statistics. Morgan Stanley Research. 12
  13. 13. Michigan Unemployment @ 11.6%, Up Nearly 2x Y/Y USA @ 7.6%, On Way to California Level of 10.1%? U.S. State Unemployment Rates, 1/08 vs. 1/09 13% Jan-08 Jan-09 1/09 National Average 11.6% 11% 10.4% 10.3% 10.1% 9.9% 9.7% 9.4% 9.3% 9.2% 8.8% 8.7% 8.7% 8.6% 8.6% 9% Unemployment Rate 7.3% 7% 6.3% 6.1% 5.9% 6.0% 5.7% 5.7% 5.5% 5.3% 5.3% 5.3% 5.2% 5.0% 4.8% 5% 3% y a o n nd a ia a an a ia C ee i pp ck ad in an in hi go D rn rg s ig la ol ol O si tu es ev n di ifo re eo h Is ar ar to s en In ic O nn N si G al de ng C C M is K C Te th h ho hi M ut or as R So N W Note: 2/09 preliminary U.S. national unemployment rate was 8.1%. Source: Bureau of Labor Statistics. Morgan Stanley Research. 13
  14. 14. Rising Unemployment Higher Mortgage Defaults… U.S. Residential Mortgage Delinquency Rates Initial Claims For Unemployment Insurance Y/Y Growth 40% vs. Initial Claims For Unemployment Insurance 100% Residential Mortgage Delinquency Rates Y/Y Growth Y/Y Growth, 1973 - 2008 80% 30% 60% 20% 40% 10% 20% 0% 0% -10% -20% -20% -40% 1973 1976 1980 1983 1987 1990 1994 1997 2001 2004 2008 U.S. Residential Mortgage Delinquency Rates Y/Y Growth U.S. Initial Claims For Unemployment Insurance Y/Y Growth Note: Both mortgage delinquency rates and initial claims for unemployment insurance are seasonally adjusted. Source: Mortgage Bankers Association, Bureau of Labor Statistics, Morgan Stanley Research. 14
  15. 15. …Higher Unemployment / Mortgage Defaults Rising Personal Bankruptcy Filings… U.S. Weekly Personal Bankruptcy Filings, Y/Y Growth, 2000 - 2009 150% 100% 50% 0% -50% -100% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Note: “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005” went into effect on 10/17/05, causing anomalies in the Y/Y growth series from late 2005 through early 2007. Source: Lundquist Consulting, US Census, Administrative Office of the US 15 Courts, Morgan Stanley Research, Betsy Graseck, Cheryl Pate and Justin Kwong.
  16. 16. … Consumer Confidence Falling Overall Consumer Spending Survey Results – 6/06 - 2/09 Would you say your overall spending over the next 90 days will be more than last year, less than last year, or the same as last year? – 60% survey respondents now saying they’ll spend less money 60% Spending More Spending Less 2/09 61% 50% 40% 30% 20% 10% 0% Jun-06 Nov-06 Mar-07 Jun-07 Sep-07 Jan-08 Apr-08 Jul-08 Sep-08 Dec-08 Feb-09 Note: Survey based on responses of 2,715 U.S. consumers. Source: Changewave, 2/18/09. 16
  17. 17. Average Consumer Wealth Destruction = ~25% Through CQ4:08 – 56%+ of USA Household Assets in Real Estate + Stocks USA Household Asset Breakdown, C2007A Real Estate & Equities Market Performances, % Change from CQ1:07 10% Credit Market Instruments 7% Others 3% 0% % Change from CQ1:07 Deposits -10% 12% Real Estate 38% -20% Pension Reserves -30% 22% Equities + Mutual Funds -40% 18% CQ1:07 CQ3:07 CQ1:08 CQ3:08 S&P/Case-Shiller Home Price Index S&P 500 Index Note: Median household income in 2007 was $50,233, per U.S. Census Bureau. 56% accounts only real estate + equities / mutual funds; many pension funds also invest in the U.S. equities market, thus actual exposure to these asset classes will likely be higher. The total value of all USA household’s real estate + equities + mutual funds + pension fund reserves declined 25% from the peak in CQ2:07; the Y/Y decline in CQ4:08 is -21%; the Y/Y decline of total household assets in CQ4:08 is -15%. Source: Federal Reserve; Standard & Poor's; Morgan Stanley Research. 17
  18. 18. Difficult Retail Environment Abercrombie & Fitch Same-Store Sales UK Retail Same-Store Sales Y/Y % Change, 1/08 – 2/09 Y/Y % Change, 1/08 – 2/09 10% 10% 6% 5% 5% 3% Comparable Store Sales Y/Y % Change Comparable Store Sales Y/Y % Change 2% 2% 1% 0% 0% 0% 0% -1% -2%-1% -1%-1%-1% -2% -2%-3% -2% -5% -3% -5% -3% -7% -10% -10% -10% -11% -15% -14% -15% -20% -20% -20% -20% -25% -24% -25% -30% -28% -30% -30% Jan Mar May Jul Sep Nov Jan Jan Mar May Jul Sep Nov Jan Note: Same-store sales are sales in stores open more than one year. Source: Abercrombie & Fitch, British Retail Consortium. 18
  19. 19. Retail Sales + e-Commerce Growth Rates Slowing Adjusted Retail Sales vs. Adjusted E-Commerce Sales Y/Y Growth, CQ3:01 – CQ4:08 40% 30% 20% Y/Y Growth 10% 0% -10% CQ3:01 CQ3:02 CQ3:03 CQ3:04 CQ3:05 CQ3:06 CQ3:07 CQ3:08 US Adjusted Retail E-Commerce Sales US Total Retail Sales Note: E-Commerce adjusted for eBay by adding eBay US gross merchandise volume and subtracting eBay US transaction revenue; Source: US Dept. of Commerce (CQ4:08), Morgan Stanley Research. 19
  20. 20. Corporate Sales – Increasingly Below Plan Since CQ1:06 Overall Corporate Sales Survey Results, CQ1:01 – CQ4:08 How is your company doing with regard to meeting its sales plan revenue objectives for the current quarter? Are you coming in above plan, even, or below plan? 60% CQ3:01 CQ4:08 50% Above Plan Below Plan 51% 50% 40% 30% 20% 10% 0% CQ1:01 CQ4:01 CQ3:02 CQ2:03 CQ1:04 CQ4:04 CQ3:05 CQ2:06 CQ1:07 CQ4:07 CQ3:08 Note: Survey based on responses of 3,029 U.S. respondents. Source: Changewave, 12/5/08. 20
  21. 21. Material Revenue Growth Declines – TMT Companies Intel + Nokia = Accelerating -20%+ Declines 75% TMT Companies Revenue Y/Y Growth, CQ1:07 – CQ1:09E 60% Y/Y Revenue Growth 45% 30% 15% 0% -15% -30% CQ1:07 CQ3:07 CQ1:08 CQ3:08 CQ1:09E Microsoft Intel Cisco Nokia Disney Viacom* News Corp Time Warner Yahoo! Google Amazon.com eBay AT&T Verizon Note: CQ1:09E figures based on FactSet consensus estimates; CQ4:08 for VIA is an estimate. Source: Company data, FactSet, Morgan Stanley Media Research. 21
  22. 22. Technology Revenue – So far, a 2001 Redux of 5 Flat / Down Sequential Quarters…Now 4…This Time, Secular Outlook Worse Global Technology Sector Revenue & Y/Y Growth, CQ1:98 – CQ4:08 700 35% 30% 600 Average Y/Y Growth = 11% 25% 500 20% Y/Y Growth Revenue ( $B) 15% 400 10% 300 5% 200 0% -5% 100 -10% 0 -15% CQ1:98 CQ3:99 CQ1:01 CQ3:02 CQ1:04 CQ3:05 CQ1:07 CQ3:08 Revenue Y/Y Growth Note: Revenue and Y/Y Growth compiled from 570 publicly traded global technology companies. Source: FactSet, Morgan Stanley Research. 22
  23. 23. USA Manufacturing Contracting Rapidly – 12/08 PMI Index Lowest Level Since 1980, 2/09 PMI = 35.8 80 U.S. PMI (Purchasing Managers Index), 1/48 – 2/09 PMI > 50 = 70 Expansion 60-year Average = 52.7 60 ISM PMI Index (%) 50 40 Oct 2001 Feb 1991 PMI < 50 PMI=40.8 PMI=39.4 = May 1982 30 Contraction Dec 2008 PMI=35.5 PMI=32.9 20 99 02 05 08 90 93 96 66 69 72 75 78 81 84 87 60 63 57 48 51 54 19 19 20 20 20 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 Note: PMI is a composite index based on five major indicators including: new orders, inventory levels, production, supplier deliveries, and employment environment. A PMI index over 50 indicates that manufacturing is expanding while anything below 50 means that the industry is contracting. Source: Institute for Supply Management (ISM), Morgan Stanley Research. 23
  24. 24. -6.2% Q/Q USA GDP Growth in CQ4 / Consumer Spending Fell 4.3% Biggest Q/Q Decline in GDP / PCE Since CQ1:82 / CQ2:80 U.S. Real GDP vs. Real Personal Consumption Expenditures (PCE) Q/Q % Change, 2005-2008 5% 3% Q/Q Growth Rates 1% CQ1:05 CQ3:05 CQ1:06 CQ3:06 CQ1:07 CQ3:07 CQ1:08 CQ3:08 -1% -3% -5% -7% U.S. Real GDP Q/Q Growth U.S. Real PCE Q/Q Growth Note, Real GDP and real PCE are inflation- and seasonally adjusted; CQ4:08 data is preliminary, may differ from final reported #s. -6.2% Q/Q real GDP decline is the largest since CQ1:1982; -4.3% Q/Q real PCE decline is the largest since CQ2:1980. 24 Source: BEA, Morgan Stanley Research.
  25. 25. Global GDP Growth Forecasts = Continued Trend of Downward Revisions Difference from IMF Forecasts, 1/09 11/08 IMF Forecasts Country / Region 2007 2008 2009E 2010E 2009E 2010E USA 2.0% 1.1% -1.6% 1.6% -0.9% 0.1% Euro zone 2.6 1.0 -2.0 0.2 -1.5 -0.7 UK 3.0 0.7 -2.8 0.2 -1.5 -0.9 China 13.0 9.0 6.7 8.0 -1.8 -1.5 India 9.3 7.3 5.1 6.5 -1.2 -0.3 Russia 8.1 6.2 -0.7 1.3 -4.2 -3.2 Brazil 5.7 5.8 1.8 3.5 -1.2 -1.0 Developed Markets(1) 2.7 1.0 -2.0 1.1 -1.7 -0.5 Emerging Markets(2) 8.3 6.3 3.3 5.0 -1.8 -1.2 World 5.2 3.4 0.5 3.0 -1.7 -0.8 Note: (1) IMF equivalent of “advanced economies”; (2) IMF equivalent of “emerging and developing economies”; Source: International Monetary Fund (IMF) World Economic Outlook (WEO) database, 1/09. Morgan Stanley Research. 25
  26. 26. Stock Markets Stabilizing = Leading Indicator of Economic Growth Russia off 74% vs. 36-Month Peak, Oil -67% / China -63% / India -57% / Japan -56% / S&P500 -49% 500 2006 2007 2008 450 400 Indexed Value (base = 100) 350 300 250 200 150 100 50 0 3/06 6/06 9/06 12/06 3/07 6/07 9/07 12/07 3/08 6/08 9/08 12/08 3/09 S&P 500 NASDAQ Composite Index China Shanghai SE Composite India SENSEX Russia RTS Light Crude Oil - Continuous Contract Gold - Continuous Contract Japan Nikkei 225 Note: all indices start at a value of 100 on 3/17/06; data as of 3/18/09; Source: FactSet. 26
  27. 27. S&P500 – Key Spending Sectors Have Taken Big Hits Total Mkt % Change Cap ($B) 2009 Peak to S&P Sector 3/18/2009 2007 2008 YTD Current (1) Market Cap Leaders Financials 825 -20% -52% -23% -71% JPMorgan, Wells Fargo Industrials 661 7 -40 -27 -58 GE, United Technologies Consumer Discretionary 618 -18 -38 -14 -54 McDonald's, Walt Disney Materials 229 14 -45 -9 -50 Monsanto, DuPont Information Technology 1,255 12 -43 -4 -46 Microsoft, IBM Telecom Services 281 -12 -34 -9 -44 AT&T, Verizon Energy 936 36 -37 -15 -42 Exxon, Chevron Utilities 294 6 -28 -14 -39 Exelon, Southern Health Care 1,065 1 -24 -11 -35 Johnson & Johnson, Pfizer Consumer Staples 998 10 -20 -14 -29 Wal-Mart, Procter & Gamble (2) S&P 500 Total 7,506 1% -37% -14% -49% Note: (1) % Change from S&P 500 peak on 10/9/07 to 3/18/09; (2) S&P 500 total market cap and % change, different from S&P 500 index price & % change. Source: Bloomberg, Morgan Stanley Research. 27
  28. 28. S&P500 Down 39% in 2008, 2nd Worst in 183 Year History – Bad Years Often Follow Good Years 2007 2005 1994 1993 1992 1987 1984 1978 1970 1960 2006 1956 2004 1948 1988 1947 1986 1923 1979 1916 1972 1912 1971 2000 1911 1968 1990 1906 1965 1981 1902 1964 1977 1899 1959 1969 1896 1952 1962 1895 1949 1953 1894 1944 2003 1946 1891 1926 1999 1940 1889 1921 1998 1939 1887 1919 1996 1934 1881 1918 1983 1932 1877 1905 1982 2001 1929 1875 1904 1976 1973 1914 1874 1898 1967 1966 1913 1872 1897 1963 1997 1957 1903 1871 1892 1961 1995 1941 1890 1870 1886 1951 1991 1920 1887 1869 1878 1943 1989 1917 1883 1868 1864 1942 1985 1910 1882 1867 1858 1925 1980 1893 1876 1866 1855 1924 1975 1884 1861 1865 1850 1922 1955 1873 1860 1859 1849 1915 1950 2002 1854 1853 1856 1848 1909 1945 1974 1841 1851 1844 1847 1901 1938 1958 1954 2008 1930 1837 1845 1842 1838 1900 1936 1935 1933 -39% 1907 1831 1835 1840 1834 1880 1927 1928 1885 1857 1828 1833 1836 1832 1852 1908 1863 1879 1931 1937 1939 1825 1827 1826 1829 1846 1830 1843 1862 -50 to -40% -40 to -30% -30 to -20% -20 to -10% -10 to 0% 0 to 10% 10 to 20% 20 to 30% 30 to 40% 40 to 50% 50 to 60% Note: S&P 500 historical info from 1825 to 2007. 28 Source: Value Square Asset Management, Yale University.
  29. 29. Current USA Bear Market – 3rd Worst in History Duration Still Relatively Short S&P 500 Peak-to-Trough Rank Magnitude (%) Duration Days Start Date End Date 1 -86% 704 1929 - Sep 16 1932 - Jul 8 2 -60 1,284 1937 - Mar 10 1942 - Apr 28 3 -55 497 2007 - Oct 9 TBD 4 -49 637 2000 - Mar 24 2002 - Oct 9 5 -49 459 1906 - Jan 19 1907 - Nov 15 6 -48 436 1973 - Jan 11 1974 - Oct 3 7 -46 602 1901 - Jun 17 1903 - Nov 9 8 -44 283 1919 - Nov 3 1920 - Dec 21 9 -40 268 1916 - Nov 21 1917 - Dec 19 10 -36 389 1966 - Nov 29 1970 - May 28 11 -34 71 1987 - Aug 25 1987 - Dec 4 12 -30 761 1946 - May 29 1949 - Jun 13 13 -29 1,178 1909 - Nov 19 1914 - Jul 30 14 -28 136 1961 - Dec 11 1962 - Jun 26 15 -27 430 1980 - Nov 28 1982 - Aug 12 Note: Current bear market is on-going, data as of 3/19/09, duration only includes trading days. Source: ISI. 29
  30. 30. 5 Weeks in History – Financial Services Restructuring (~$3T in US Aggregate Sector Market Value 1/1/07…now $0.8T) Dow Jones Industrial Average, 9/8/08 – 10/14/08 September 7 September 14 September 16 September 22 September 25 September 29 October 3 October 14 11,600 GSEs / Lehman AIG MS / MUFG JPM Fortis Wells Fargo Leading 11,400 Bankruptcy Nationalized Investment Acquires Nationalized Acquires Banks Enter Washington 11,200 Plan WaMu Wachovia Preferred BofA GS / B&B Stock 11,000 Acquires ML Berkshire Nationalized $700Bn Purchase Dow Jones Industrial Average Investment TARP Program 10,800 10,600 UK Bank Bail 10,400 Out 10,200 Santander / Sovereign 10,000 9,800 9,600 9,400 9,200 9,000 8,800 (23%) 8,600 8,400 United States Europe Note: Aggregate sector market value is the combined market cap for all companies in the S&P500 financials index, $2.9T as of 1/1/08, $0.8T as of 3/18/09. 30 Source: Morgan Stanley IBD; Bloomberg.
  31. 31. Credit Spreads @ 100-Year Extreme – Current Level Down From 12/08 Peak, But Still 250bps+ Higher Than Post-Depression Peaks Credit Spreads (to U.S. Treasury Securities), 1925 - 2009 Current (3/09) Level: 655 bps 600 Spread to Tsy (bps) 400 200 0 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 BBBs (to Tsy) AAA/AA (to Tsy) Source: Moody’s, Yield Book, Morgan Stanley Credit Strategy Research. 31
  32. 32. Stock Market Volatility Implies High Uncertainty – VIX Index Down From All-Time High But Still High Chicago Board Options Exchange (CBOE) Volatility Index, 1990 - 2009 80 60 VIX Index Value (%) 40 20 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Note: Data N/A before 1990. VIX is a measure of implied volatility of S&P 500 index options. Source: FactSet. 32
  33. 33. When Does Vicious Cycle End? More Often Than Not, Peak Unemployment = Good Time to Invest S&P 500 Index & U.S. Unemployment Rates, 1928 - 2008 10000 30% 25% 1000 S&P 500 Index Value (Log Scale) Unemployment Rate 20% 100 15% 10% 10 5% 1 0% 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 Recessions S&P 500 Index Price Unemployment Rate Unemployment Peak Note: Unemployment rates from 1928–1943 are annual estimates from John Dunlop and Walter Galenson’s Labor in the Twentieth Century (1978); data unavailable between 1943-1948; Post 1948 unemployment data from BLS, peaks are: 9/49 - 7.9%; 9/54 - 6.1%; 7/58 - 7.5%; 5/61 – 7.1%; 8/71 - 6.1%; 5/75 - 9.0%; 11/82 - 10.8%; 6/92 - 7.8%; 7/03 - 6.3%. Latest data shows 2/09 unemployment rate at 8.1%, 270 basis points below 11/82 peak. 33 Source: FactSet; Bureau of Labor Statistics. Morgan Stanley Research.
  34. 34. Sequencing the Asset Recovery Process – High Quality Financials / USA Non-Cyclicals / IG Super Senior Should Lead the Way Recovery Phasing and Duration Start End High Quality Financials US Domestic Non-Cyclicals Investment Grade (IG) Super Senior Europe/Asia Non-Cyclicals IG Senior IG Equity Tranche CLO AAAs IG Cyclicals US High Yield IG Junior Mezz CMBX Ajs EU High Yield US Loans EU Loans Asia High Yield Note: The yellow bars represent the relative phasing in and out, as well as the duration of the recovery process for each asset class. For example, in our view, high quality financials will recover first, and Asia high yield will be among the last. IG is Investment Grade; CLO is Collateralized Loan Obligations; Source: Gregory Peters, Sivan Mahadevan, Neil McLeish, Morgan Stanley Global Credit Strategy Research. 34
  35. 35. Advertising Spending & GDP Growth = High Correlation of 81% U.S. Advertising Spending Y/Y Growth vs. Real GDP Y/Y Growth, 1986 – 2007 20% 15% U.S. Ad Spend vs. GDP, Y/Y Growth 10% Median Y/Y Ad Spend Growth Rate = 5% 5% 0% 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 -5% 1991 Ad Growth = -2% 2001 Ad Growth = -12% -10% U.S. Real GDP Y/Y Growth U.S. Ad Spend Y/Y Growth Source: Zenith Optimedia, IMF, Morgan Stanley Research. 35
  36. 36. Simple Regression Analysis: 1) Ad spend growth 3x sensitivity of real GDP growth 2) If GDP flat in 2009E, ad spend could decline ~4% Y/Y U.S. Advertising Spending vs. Real GDP y = 3.0263x – 0.0394 20% 1986 – 2007 R2 = 0.6553 y – ad spend growth x – real GDP growth 15% Ad Spend Y/Y Growth If real GDP Ad spend Y/Y growth Y/Y growth 10% is… could be… 5% 11% 4 8 5% 3 5 2 2 1 -1 0% 0 -4 -1% 0% 1% 2% 3% 4% 5% -1 -7 -2 -10 -5% -3 -13 Real GDP Y/Y Growth -4 -16 -5 -19 -10% U.S. Ad Spend vs. Real GDP Y/Y Growth Linear Regression Line (y = 3.0263x - 0.0394 R^2 = 0.6553) Note: R2 of 0.655 indicates that correlation is not perfect (n=22), and correlation does not equal causation. Source: Zenith Optimedia, IMF, Morgan Stanley Research. 36
  37. 37. Online Ad Spending Bad News = From 2000 to 2002, USA Spending Fell 27% $25,000 U.S. Online Advertising Spending & Y/Y Growth Rates, 1996-2007 250% $21,206 200% $20,000 U.S. Online Ad Spending ($MM) $16,879 150% Y/Y Growth Rate $15,000 $12,542 100% $10,000 $9,475 $8,225 $7,134 $7,267 50% $6,009 $4,621 $5,000 0% $1,921 $907 $267 $0 -50% 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 U.S. Internet Ad Spending Y/Y Growth Rate Source: IAB, Morgan Stanley Research. 37
  38. 38. Online Ad Spending Good News = Now, Less Ad ‘Over Spending’ vs. Trend Line However, Q/Q Pattern Looks a Bit Like Early 2001 U.S. Online Advertising Spending & Y/Y Growth Rates, CQ1:96-CQ3:08 $6,000 300% U.S. Online Spending & Search Revenue ($MM) 250% $5,000 Total U.S. Online Spend Y/Y Growth 200% $4,000 150% $3,000 100% $2,000 50% $1,000 0% $0 -50% 3/96 3/97 3/98 3/99 3/00 3/01 3/02 3/03 3/04 3/05 3/06 3/07 3/08 U.S. Online Ad Spending Spending on Search Y/Y Growth Online Ad Spend Polynomial Trendline Note: CQ3:08 search spending data not available. Source: IAB, Morgan Stanley Research. 38
  39. 39. Technology / Internet 1) Digital Consumer – Our bet = At margin, consumers spend more – not less – time on Internet in difficult times – it’s a cheap / efficient / transparent thrill! Undermonetized social networks / video / VoIP driving powerful usage growth – opportunity for innovative marketers to capitalize on low CPMs 39
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