Goldman Sachs 2003 Annual Report Download - page 35

Management’s Discussion and Analysis
GOLDMAN SACHS 2003 ANNUAL REPORT 33
decline, demand for capital increased and transaction
volumes remained at low levels. We did, however, see
increased trading and investing opportunities for our
clients and ourselves in 2003, in part due to some of the
same economic shocks and trends that have created chal-
lenging conditions for some of our other businesses in
recent years. We increased our market risk in 2003 to
take advantage of these perceived opportunities. Finally,
in the current regulatory environment, corporations gen-
erally and financial services firms in particular have been
subject to wide criticism and intense scrutiny and, conse-
quently, the volume and amount of claims against finan-
cial intermediaries are increasing. Given the range of
litigation and investigations presently under way, our lit-
igation expenses may remain high. For a further discus-
sion of these trends and other factors affecting our
businesses, see “— Certain Factors That May Affect
Our Business” included herein as well as in our Annual
Report on Form 10-K for our 2003 fiscal year.
BUSINESS ENVIRONMENT
As an investment banking, securities and investment
management firm, our businesses are materially affected
by conditions in the financial markets and economic con-
ditions generally, both in the United States and elsewhere
around the world. A favorable business environment is
generally characterized by low inflation, low and declin-
ing interest rates, and strong equity markets. Over the
business cycle, these factors provide a positive climate for
our investment banking activities, for many of our trad-
ing businesses and for wealth creation, which contributes
to growth in our asset management businesses. In recent
years, we have been operating in a challenging environ-
ment for many of our businesses, characterized by equity
market declines from record highs, lower levels of corpo-
rate activity, and a decline in investor confidence resulting
from, among other factors, several highly publicized
financial scandals and geopolitical uncertainty. However,
in the second half of 2003, the business and economic
environment improved somewhat around the world. For
a further discussion of how market conditions can affect
our businesses, see “— Certain Factors That May Affect
Our Business.” A further discussion of the business envi-
ronment in 2003 is set forth below.
global – The pace of growth in the global economy
improved in the second half of 2003, after a period of
subdued growth earlier in the year. Geopolitical factors,
particularly relating to the conflict in Iraq, and ongoing
concerns about the sustainability of the economic recov-
ery restrained capital spending in the early part of the
year. Diminishing concerns and easing global monetary
policy led to a stabilization of global activity around
midyear, followed by an increase in activity in the second
half of 2003. In particular, the U.S. economy showed a
sharp increase in economic growth in the second half,
helped by fiscal and monetary stimulus. Global equity
markets remained generally weak in the early part of the
year, but rallied strongly from March, reflecting expecta-
tions of an improvement in the economic environment
and corporate profitability. The fixed income markets,
which generally performed well for a third straight year,
were characterized by tightening corporate credit
spreads, low interest rates, a steep yield curve and strong
customer demand. In the currency markets, the U.S. dol-
lar continued to weaken through the year, falling signifi-
cantly against most major currencies. Corporate activity,
as measured by industry-wide completed mergers and
acquisitions and equity underwriting volumes, remained
low. However, industry-wide debt origination levels
increased significantly from 2002.
united states – The U.S. economy grew at a modest pace
in the first half of the year, but improved in the second half.
Real gross domestic product in the 2003 calendar year rose
by approximately 3.1%, with quarterly growth rising from
1.4% (annualized) in the first quarter to over 8% in the
third quarter. The U.S. Federal Reserve reduced the federal
funds rate target by 25 basis points in June in response to
continued economic weakness and the risk of deflation.
The easing in monetary conditions, combined with a large
fiscal stimulus package and moderating geopolitical uncer-
tainty, contributed to a sharp improvement in economic
growth around midyear, as both consumer and investment
spending picked up strongly. In addition, high productivity
growth restrained labor costs and underpinned a sharp
increase in corporate profitability through 2003. Indications
from the Federal Reserve that it was prepared to act aggres-
sively to prevent the risk of deflation, contributed to the
10-year U.S. Treasury note yield falling to 45-year lows in
June. However, long-term yields subsequently rose sig-
nificantly as the economic environment improved.
europe – Economic conditions in Europe generally
remained weak through most of 2003. Real gross domes-
tic product growth in Europe, which was approximately
1.0% for the 2003 calendar year, was among the weakest
in a decade, as firms continued to cut back on investment
through much of the year. The Eurozone economies
recorded negative growth in the first half of the 2003
calendar year, although a recovery in global activity led
to modest economic growth in the second half of the year.
The European Central Bank lowered interest rates by 125
basis points in the aggregate between December 2002 and
June 2003 in response to continuing economic weakness.
The U.K. economy continued to grow at a modest pace,
but was stronger than continental Europe, primarily due
to increased consumer spending. Improving economic
activity in the latter part of the year led the Bank of