April 2005 Executive Summary

Prepared by David G. Sowerby, CFA
Loomis, Sayles & Company, LP

Lansing-area economic activity moderately gained in the first quarter. The Greater Lansing Business Index rose to a preliminary level of 120.0 in March compared with 115.7 at the end of 2004. Although the index was slightly higher than December 2004 levels, the local business climate is approximately unchanged compared with year ago levels.

Over three years into a national economic recovery, there has been little sign that Michigan and Lansing have participated with any meaningful growth. In early April, the latest jobless figures put the state at 6.9 percent. In comparison, the U.S. unemployment rate is 5.4 percent.

More than any statistic, the unemployment rate registers as the highest profile economic measure among average Americans. Professionals know that the unemployment rate is a lagging variable that is usually one of the slowest gauges to witness improvement in an economic recovery. This has especially been the case in Midwest states as a global competitiveness has necessitated corporate restructuring into a recovery. Recently, job growth has been improving at the national level and slightly, within Michigan.

In this expansion, there is arguably one of the greatest polarizations of growth nationally versus locally in the last 40 years. The cause is both cyclical and structural. Of the two, there is better news coming on the cyclical front, as the following key measures should enhance local economic prospects:

STATE OF MICHIGAN AND METRO LANSING BUSINESS BALANCE SHEET – APRIL 2005

1. Corporate Michigan – remains healthy
2. State revenue growth accelerating
3. Exports improving, imports slowing due to dollar depreciation
4. State tax climate competitive
5. Above average GDP growth traditionally favors Michigan job and income growth

Data Source: Loomis, Sayles & Company, LP

Indeed, there are greater signs that the cyclical recovery is improving for the regional and local business environment. Local area corporate earnings should witness a 20 percent gain in 2005, even when including the recent profit estimate reductions for several auto companies. Retail spending has expanded above average in the face of high-energy prices, perhaps owing to household net worth reaching record levels in late 2004.

The structural (i.e., secular) factors provide greater concern. For example, as an investor, I am less discouraged by the market’s cyclical ups and downs. The downs create buying opportunities through the temporary misallocation of funds. However, if the long-term returns of the market were somehow diminished, wealth creation would surely suffer. Unfortunately this is the case for the local economy. Reasons include:

• The persistent lagging performance of motor vehicle industry Return on Invested Capital (ROIC) versus the competition.
• The below average growth in human capital, specifically the proportion of college degrees awarded to Michigan residents vis-à-vis the nation.
• The greater outflow in publicly traded headquartered companies in Michigan versus new entrants, (i.e., new publicly traded IPOs), a reflection of slower small business expansion in higher growth industries.
• The tax structure, which lists Michigan as an average state when ranked by competitiveness for the cost of doing business.

Specific to the last item, Michigan formerly ranked in the bottom quartile for competitiveness at the beginning of the 1990s before significantly improving. Most recently we have maintained our ranking by avoiding raising major taxes such as property, personal income and sales. However, being median is not sufficient to promoting the needed catalyst for improving our cyclical and structural prospects. The same can be said about Lansing and the need to enhance its competitive position.

The cyclical recovery that is normally present in the ups and downs of the economic cycle has been slow to start, but nevertheless has gained some traction in the last six months. The structural impediments to above average long-term growth remain sobering for anyone who seeks a high quality of life in our regional economy.

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