Analysis: Modest Growth Ahead

Nicholas Perna is the economic adviser to Webster Financial Corp. and chief economist and managing director of the consulting firm Perna Associates. He is also a visiting lecturer at Yale University. He is a regular guest on Public Television’s The News Hour with Jim Lehrer.

Third-quarter earnings came out better than expected. In the S&P 500 the ratio of companies that beat expectations by 2 percent or more to those that missed by 2 percent or more was 7 to 1, although the revenue ratio of those that beat to those that missed was 2 to 1. What does that say, especially in light of the stock market’s plunge on Friday?

N.P.: Why is the stock market down? It’s hard to say. Could it be that it was reported on Friday that consumer spending in September took a drop? When two-thirds of the economy doesn’t rise, that gets people’s attention.

But I think it’s an overreaction, because the third-quarter 3.5 percent rise in Gross Domestic Product included an estimate of what happened in September. The implication from September is that fourth-quarter GDP growth will be positive but smaller than 3.5 percent.

What we’re getting is a modest recovery from a deep recession.

All I hear is that the stock market’s direction is dominated by the dollar’s value. Dollar up means stocks down. Is it that simple?

N.P.: No, because what markets do is they have their fascination du jour. Right now they’re fascinated with the dollar, so it’s the dollar exchange rate is driving everything. In the not-too-distant future it will be expectations of what the Federal Reserve will do on interest rates that will dominate everything.

Basically, markets have a case of Obsessive Compulsive Disease, but they get compulsive about different things over time.

Now, what should you want — a rising or a falling dollar? If you plan to travel to Europe or import Chianti, you clearly want a stronger dollar. But most Americans benefit from an orderly decline in the dollar, because it makes American exports more attractive overseas. It makes imports less attractive here, and it increases the value of overseas earnings that are repatriated by U.S. companies.

The dollar has weakened significantly in the last couple of months. Back in late spring a euro costs you about $1.30, while now it goes for $1.50. I think much of that is simply a reversal of the strengthening of the dollar that took place in prior months when money was pouring into the United States seeking a safe haven from financial chaos. The recent decline in the dollar is a reflection of improving financial conditions around the globe.

Over time, the dollar will continue to decline to reduce our trade deficit and our dependence on foreign capital.

The job losses and initial and continuing unemployment claims just keep coming. Assess the situation and its effect on the economy.

N.P.: So far they’re no surprise. We expected the GDP to start turning around before the labor market. However, the deterioration has gotten smaller. At the beginning of 2009 we were losing about 700,000 jobs a month, and now it’s down to about 250,000. It’s still a big number and there’s a lot of pain there, but we’re getting closer to zero, but we have a way to go.

Most economists don’t expect the job market to turn around for another six months or so. One reason is that businesses have cut hours of work significantly in the recession and will restore work schedules before hiring new people.

Are we heading toward the second leg of a double-dip recession?

N.P.: The dreaded double dip? It’s possible but less likely than modest growth. We’ve got some momentum that should carry us for a while.

For example, this is the stage of the recovery when inventories start kicking in as a booster rocket. During the decline, businesses had to cut inventories faster than sales drops to keep the shelves from getting overloaded. Now when demand increases, they have to raise production even faster to restock the shelves. This helps you for a few quarters, so it’s a stimulus.

But there are risks, one of which is a too-rapid decline in the dollar exchange rate, which could push interest rates up. Another is a too-rapid rise in interest rates by the Federal Reserve, but that seems unlikely.

Housing sales were weaker than expected for September. What’s your take?

N.P.: We’re seeing signs of stability. One of the most closely watched gauges of house prices, the national Case-Shiller Index, has risen for three months in a row. It’s still way off from the peaks, but it’s giving indication that the long slide in house prices is finally coming to an end.

What about Connecticut?

N.P.: There is a lot of concern and uncertainty over the budget. Many of us are afraid that it’s already out of balance, which would raise the level of uncertainty by the bond rating agencies as well as taxpayers.

If the credit rating were to be downgraded, everyone knows it would cost the state more to borrow. However, there’s another effect: The higher interest rates would automatically make the bonds held by thousands of Connecticut residents worth less. People don’t factor that in. It’s like a tax on their bond holdings.

What do you think about huge bonuses banks and financial houses will shower on top executives and efforts to legislate against it?

N.P.: Since I’m not getting one, I don’t think they’re a great idea. But seriously, I don’t think there’s an awful lot legislation can do about this. But this is where corporate governance and shareholders can have a big role. We need boards of directors who take their responsibilities to shareholders seriously. Where were all the pension funds that have voting rights over lots of shares when all these bonuses were being paid out in the past? It seems to me that the shareowners through the boards of directors can decide compensation much better than Congress can legislate it. I would think there’s a community of interest among pension funds in getting the returns and making sure they’re not being diverted into excess executive compensation.