Interview With Nicholas Perna: Modest Growth In 2013, After Sequester And Payroll Tax Hike Cut 1.5% Off GDP

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by: Harlan Levy

Economist Nicholas Perna is the economic adviser to Webster Financial Corp. and managing director of consulting firm Perna Associates. He is also a visiting lecturer at Yale University.

Harlan Levy: Did March's poor job numbers - only 88,000 new jobs - change your outlook on the U.S. economy?

Nicholas Perna: Actually it hasn't. I make an economic forecast once a month for the Wall Street Journal Survey of Economic Forecasters, and I've been doing it for 25 years. Not to boast, but last year my forecasts came out in the top quintile of forecast accuracy. In any event, what I said in the forecast I submitted last month was that the year would start off with a pick-up in Gross Domestic Product and then subside to a more moderate pace. What we're seeing with the jobs numbers is consistent with that.

Net-net for 2013, I still expect modest economic growth. I'd say 2.5 percent real GDP and a slight decline in the unemployment rate to about 7.4 percent.

H.L.: March's jobless rate was down to 7.6 percent. Is that significant?

N.P.: The decline is not really good news, because it was brought to you by lower labor force participation. The labor force is not growing. In fact it shrunk in March, because people can't find jobs, or they're not entering the workforce. This is starting to be of concern, because over the last year virtually all of the decline in the jobless rate has been brought to you by very slow labor force growth. If the job market was getting dramatically better, as some thought, we would see the labor force growing, as more people look for work.

H.L.: Are the real causes of the low job gain the sequester, the end of the payroll tax holiday, Obamacare, and Cyprus?

N.P.: All of those are playing a role. We can quantify the first two, the sequester and the payroll tax. Because of those, what's happened is that something like 1.5 percent of GDP has been sucked out of the economy. That explains why we expect modest growth this year.

Cypus and Obamacare are much more difficult to quantify, although they do retard growth. Cyprus is a tiny country that could have caused and still could cause substantial problems for the world financial system because of the uncertainty over whether it may exit the euro zone and whether the actions taken would cause runs on banking systems elsewhere in the euro zone.

As for Obamacare, we don't have data on whether businesses are trying to restructure hiring to avoid the costs.

H.L.: Earnings season begins this week. Do you expect weakness in light of the worst negative sentiment since 2003?

N.P.: We've had a really good run-up in earnings, since the bottom of the recession and a bigger run-up in the stock market, but I think looking ahead, if you count an outlook of modest economic growth in 2013 it's hard to see rapid growth in earnings. If you couple that with fairly stable low interest rates, it's hard to see large increases in the price-to-earnings ratio and thus stock prices.

H.L.: Does the poor jobs report mean that the Federal Reserve will maintain beyond the summer its program of buying Treasury bonds and mortgage-backed securities to prop up the economy?

N.P.: Probably. Because Fed Chairman Bernanke had initially talked about raising short-term interest rates when the jobless rate fell to 6.5 percent, and it might take a while to get there. Secondly, if we got there because of further declines in labor force participation, he might revise that target, saying that's not what he meant. As far as buying Treasury bonds and mortgage-backed securities, the Fed has not announced an unemployment rate when it would cut back on these purchases, but Mr. Bernanke will be very cautious in stopping the purchases too soon - before the labor market has traction. The March numbers should increase his resolve to continue these purchases as long as necessary.

H.L.: What do you see in Europe, which seems to be trending back to recession?

N.P.: I'm going to see it firsthand when I go to France in June. I keep worrying that the Europeans keep doing too little too late. We're constantly worrying about one country or another having to exit the monetary union. That's a problem, because there aren't any procedures for exiting the union, and any country that leaves could also leave chaos in its wake. If even a small country like Cyprus left, that could have the vultures circling Italy, Portugal, and Spain. As depositors, investors, and speculators all wait for the next country to leave the monetary union, that could cause capital flight and runs on banks.

The European solutions for dealing with Cyprus were outright suicidal. They were initially going to levy a tax on insured depositors, those accounts below 100,000 euros, which is tantamount to rolling back deposit insurance, which I call "kamikaze economics." What halted the bank runs in 1933 was the passage of deposit insurance. Water it down and you get bank runs. The Europeans make wonderful cars. They make terrible economic policy, so they should turn policy-making over to BMW, VW, and Ferrari.

H.L.: How would deeper European problems affect the U.S. economy?

N.P.: As for Europe becoming more shaky, if it's simply a matter of mild recession and slow growth, then it probably will hurt U.S. exports but might help U.S. financial markets a little bit, as money comes into the U.S. looking for a safe haven. Also, the dollar would strengthen However, a stronger dollar is not good for U.S. exports and not good when U.S. companies report their earnings from their European operations. If Europe plunges into a deep recession with major financial system problems, then it's hard to see equity markets in the U.S. doing well, raising the specter of another global financial crisis.

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