IHS Chief Economist Nariman Behravesh: Q2 Earnings Up Annualized 5-10%, Fed May Raise Rates In Q1 '15

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 |  Includes: DIA, QQQ, SPY
by: Harlan Levy

Summary

Chances have risen that the Fed will raise rates as early as Q1 ’15, and if the Fed prepares the market and the economy is robust, the impact won’t be big.

Stocks will go up a bit by year-end, Q2 earnings up 5-10% annualized, P/E ratios not terribly high, bubble talk exaggerated.

Job situation good, 200,000 new jobs/month at least, GDP ’14 up 1.7%, Q2 through Q4 up 3%, ’15 up 3%.

Nariman Behravesh is chief economist at economic forecasting and analysis firm IHS and is responsible for the economic outlook and risk analysis for the U.S., Europe, Japan, China, and other emerging markets.

Harlan Levy: What are the effects on the capital markets from the Federal Reserve saying it will end monthly bond purchases in October?

Nariman Behravesh: The effect of this tapering process which ends in October has already been discounted by the financial markets, which have come to accept and to factor into their market expectations that reality. The Fed has given ample warning, so the bottom line is that whatever effect there is has already happened. And we don't expect any additional impact once the bond purchases have ended.

Q: When do you think the Fed will raise interest rates, and what might that do to stocks and the U.S. economy?

A: There are a couple of things. Until two months ago our expectations and the market's expectations were that the Fed would probably raise rates late summer or early fall of 2015. However, with the economy looking perkier and especially the jobs market looking quite strong I thing the chances have risen that the Fed will raise rates earlier, possibly as early as the first quarter of 2015.

If the Fed prepares the market for an earlier rate hike and if, in particular the economy is looking quite robust, the impact on the economy is not going to be big. There will be a small negative effect on the stock and bond markets, but again, if the Fed has prepared the markets, and if the rate hike occurs when the economy is strong, then I think the markets won't be that upset.

Q: What's your outlook on equities for the rest of the year?

A: Our view right how is that the market is going to essentially go up a little bit but not very much -- in line with a strengthening economy in the second half of the year. The reasoning here is that the market has already risen a lot. So, to the extent that the markets are supposed to be forward-looking, they have already anticipated a second half strengthening of growth.

Do you see the bull market ending with no more bargains, just bubbles?

A: I think talk of bubbles is a little exaggerated. There are certainly no bubbles in markets like the commodity markets. If you look at P/E ratios they are high but not horribly high. The same thing is in the bond market. It's hard to say there's a bubble in the bond market,

I would say with any further price increases that aren't supported by decent earnings I would start to worry about those, but right now I'm not terribly worried about bubbles.

Q: What's your outlook on this new earnings season?

A: The new earnings season started out with a bit of a bang. I think you'll see a pattern where the markets anticipate that earnings for the quarter will be lackluster. Then many companies deliver above those expectations. we've seen this pattern for the last two or three years. The bar is set low, and the companies exceed those expectations. I think we're going to see a repeat of that for the next few weeks.

In terms of the growth rates we'll be looking at earnings exceeding last year in the annualized 5 to 10 percent range.

Q: What do the latest housing data - mortgage applications down 5 percent in June from May and new home purchases up 2 percent -- tell you about the housing market?

A: The housing market has taken a little bit of a hit recently for a variety of reasons. One is that the most qualified buyers got the mortgage loans they were hoping to get, and now borrowers with lower credit ratings are coming into the market, and they're having a tougher time getting mortgages. It's clear that banks are being fairly tight with their money, so we're starting to see the effects of that.

Even though housing has done well recently, we're not returning to the heyday of 10 years ago when anyone could get a mortgage loan and when housing was a leading sector. Now you're seeing a leveling off of that, a bit of a pullback. It's not a huge problem, but it is a bit of a drag on growth.

Q: Is the job situation improving much, as opposed to more and more people leaving the job market?

A: At the national level, both the household and payroll surveys indicate job growth is strong. The unemployment rate has fallen mostly because of job growth in recent months and less because of a decline in labor force participation. So the jobless rate has declined in recent months for good reasons rather than bad reasons.

In our view jobs growth going forward is likely to be at least 200,000 new jobs a month and possibly closer to 250,000. The jobs situation is looking good right now.

Q: How do you rate U.S. industrial production and manufacturing?

A: Certainly the U.S. manufacturing sector has had a bit of a nice run. U.S. manufacturers have enjoyed the fruits of a weaker dollar and the benefits they get from cheaper natural gas prices and cheaper electricity. U.S. manufacturers are getting what can be called a competitive stimulus.

If you look at the surveys, the Institute for Supply Management and the Purchasing Managers Index, they're quite robust and suggest that the manufacturing sector will continue to grow at a healthy clip.

Q: So what kind of growth, if any, do you predict for this year and 2015?

A: This year Gross Domestic Product growth will look very weak, 1.7 percent, but it's all because of that horrible first quarter. We think the average growth in the second through fourth quarters will be over 3 percent, and the average next year will also be about 3 percent.

Q: How do you describe U.S. fiscal policy and its effects?

A: Ironically, even though fiscal policy and the politics in Washington have been very problematic, the U.S. has actually made substantial progress in reducing the budget deficit, debt stabilization, and stabilizing our national debt ratio.

However, we're not out of the woods yet, because some time during the next 10 to 20 years the cost of the entitlement programs will start to rise very dramatically. This is especially true for Medicare. So, while we made progress, we still have a big challenge ahead of us.

Q: Can Congress meet it?

A: Not until after the 2016 presidential election. Until then I don't see much progress.

Q: If Congress continues to maintain spending cuts and won't extend the highway maintenance fund or spend much on infrastructure and other measures which could add jobs, and indeed won't do anything except make political points, what will happen?

A: The popularity of Congress is possibly at an all-time low, but the dilemma is that even though people may dislike Congress in general, they keep electing their own Congressmen and senators. So the question is how unhappy are they, and are they unhappy enough to vote out all the incumbents? The answer is no, so far.

The discretionary parts of the budget have been cut by quite a bit, but the issue is that more and more the entitlement programs are devouring the budget and are getting bigger and bigger. Something has to be done about controlling the growth of the entitlement programs.

Q: Some would say that the problems with radical jihadists in the Middle East, Syria, Iraq, and Afghanistan, the conflict between Russia and Ukraine, implacable European economic weakness as well as the failure to do anything about global warming are combining to lead the earth down the drain. Is the U.S. and the rest of the planet in a hopeless, negative spiral?

A: That's throwing everything in, including the kitchen sink. The world is an unstable place and has been for quite some time. But the 20th century was probably the bloodiest on record, with almost 100 million people getting killed. We're not in that situation compared with the 21st century. The conflicts in the world are much less bloody, and the casualties so far 14 years into this century have been a lot fewer. The point is that we tend to view the time period which we're in as one in which everything is going to hell in a hand basket. But we have to keep a perspective.

It's problematic because of terrorism and conflicts in a lot of different places, but the conflicts are still quite small compared to those in the 20th and 19th centuries.

Yes, things in 2008 and 2009 were bad, but in the Great Depression unemployment went up to 25 percent and took a long time to get back down. Our unemployment rate went up briefly to 10 percent, and now we're about 6 percent. So our parents are more justified in thinking that they went through a really bad time than we are. What's been happening in the 21st century is not small potatoes, but it's not been nearly as bad.

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