Goldman Sachs 2004 Annual Report Download - page 36

management’s฀discussion฀and฀analysis
34฀฀฀G O L D M A N ฀ S A C H S ฀ 2004฀ ANNUAL฀REPO RT
34฀฀฀G O L D M A N ฀ S A C H S ฀ 2 004฀ A N N U A L ฀ R E P O RT
year, a significant improvement from the previous two years, as
domestic demand rose and export performance improved.
Growth in the Eurozone economies appears to have been
stronger in the first half of the year than the second half of the
year, as consumer spending slowed from the strong first quarter,
and the strengthening euro, in part, restrained economic activity
later in the year. The European Central Bank left interest rates
unchanged through the year, but long-term bond yields fell sig-
nificantly in response to signs of softer economic activity and the
sharp rise in the euro in late 2004. The U.K. economy recorded
strong growth in 2004, though real gross domestic product
growth slowed significantly during the third quarter. After start-
ing to raise interest rates in November 2003, the Bank of England
raised interest rates during 2004 by 100 basis points. The
FTSE 100 Index increased 9% during our fiscal year.
asi a ฀–฀Japan’s economy grew very strongly in early 2004,
though the pace of growth slowed significantly after the first
calendar quarter, as investment spending and export growth
slowed. Despite slowing after the first quarter, consumer spend-
ing growth remained strong through much of 2004 and corpo-
rate profitability continued to improve. The Bank of Japan
continued to provide substantial liquidity to the market and
continued to hold short-term interest rates at zero percent
through the year. The Ministry of Finance ceased intervention to
support the Japanese yen in March 2004 and the yen remained
generally strong. Bond yields rose significantly in the middle of
the year but subsequently declined in line with global trends,
while the Nikkei 225 Index increased 7% during our fiscal year.
Growth in other Asian economies remained very strong in
2004, reflecting strong global demand growth, though the
pace of economic growth appears to have peaked in many
economies around the middle of the year. China’s growth
generally remained firm, though the pace of growth slowed in
the middle of the year, as administrative measures to slow
certain parts of the economy had a dampening effect on
investment spending. Inflation generally rose throughout the
year and, in October, the Central Bank of China increased
interest rates for the first time since July 1995, raising its
benchmark lending rate by 27 basis points.
Certain Factors That May Affect
Our Business
We face a variety of risks that are substantial and inherent in
our businesses, including market, credit, liquidity, operational,
legal and regulatory risks. For a discussion of how management
seeks to manage some of these risks, see “— Risk Management”
included below. A summary of some of the important factors
that could affect our business follows below. For a further
discussion of these and other important factors that could
affect our business, see “Business — Certain Factors That May
Affect Our Business” in Part I, Item 1 of the Annual Report
on Form 10-K.
market฀ co n d itions฀ a n d ฀ m arket฀ ri s k ฀– ฀Our businesses
are materially affected by conditions in the global financial
markets and economic conditions generally. Business conditions
continued to improve in 2004, after improving somewhat
during the second half of 2003: the number and size of equity
underwritings and completed mergers and acquisitions transac-
tions increased significantly in 2004, after declining for three
straight years, and fixed income origination levels remained
strong; fixed income market conditions remained generally
favorable, as interest rates, although rising, remained low by
historical standards, and corporate credit spreads remained
narrow; and in the global equity markets, although volatility
levels and commission rates continued to decline, price levels
and volumes were generally stronger.
Adverse or uncertain economic and market conditions have in
the past adversely affected, and may in the future adversely
affect, our business and profitability in many ways, including
the following:
•฀We have been operating in a low interest rate market for
the past several years. Increasing or high interest rates and/
or widening credit spreads, especially if such changes are
rapid, may create a less favorable environment for certain
of our businesses.
•฀We have been committing increasing amounts of capital in
many of our businesses and generally maintain large trad-
ing, specialist and investment positions. Market fluctua-
tions and volatility may adversely affect the value of those
positions or may reduce our willingness to enter into new
transactions. Conversely, our trading businesses depend on
market volatility to provide trading and arbitrage opportu-
nities, and decreases in volatility may reduce these oppor-
tunities and adversely affect the results of these businesses.
•฀Industry-wide declines in the size and number of under-
writings and mergers and acquisitions and increased price
competition may have an adverse effect on our revenues
and, because we may be unable to reduce expenses corre-
spondingly, our profit margins. In particular, because a
significant portion of our investment banking revenues are
derived from our participation in large transactions, a
decrease in the number of large transactions due to uncer-
tain or unfavorable market conditions may adversely affect
our investment banking business.
•฀Reductions in the level of the equity markets also tend to
reduce the value of our clients’ portfolios, which in turn may
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