Nariman Behravesh is chief economist at consulting firm IHS Gobal Insight and is responsible for developing the economic outlook and risk analysis for the U.S., Europe, Japan, China, and other emerging markets.
Harlan Levy: Is the stock market overvalued and going into a correction?
Nariman Behravesh: I’m not at all sure that the market is overvalued. The fundamentals in terms of earnings suggest that the market probably is fairly valued, but clearly investors are worried. They’re jittery. But in terms of profitability, in terms of cash flow, I don’t see any worries on that score. But if the numbers continue to be soft on the economy, the market could take some more hits. I don’t rule that out, but that doesn’t mean the market is overvalued.
H.L.: This week the Federal Reserve concludes QE2, which means the flood of money will suddenly stop. Can the private sector pick up the slack sufficiently to avoid a drop-off in the economy?
N.B.: The private sector already has to a large extent. The soft patch to some extent reflects those consumer and business concerns. Some of it was a lag about oil prices, but they’re down, so I expect to see consumer confidence bounce back a little bit. But then there’s also been continued worries about what’s going to happen with taxes and what’s going to happen with spending. There’s uncertainty around the fiscal contraction, which is also playing into this.
But right now this is not the beginning of a double dip, but we could see a couple of months when things could be quite soft.
HL: When do you think the economy will get robust again?
N.B.: A lot of it hinges on when consumers and businesses feel a little more comfortable about the recovery as they did last fall and in the early spring, but then they pulled back. The best guess is sometime in the late summer or early fall you’ll probably see a resurgence in the economy. We’re now saying second-half growth will be closer to 3, 3.5 percent.
H.L.: What’s the jobs outlook for the next year or two?
N.B.: We should see that the problematic May number (only 54,000 new jobs) will not be repeated, and that we’re probably going to see numbers in the 150,000-plus range going forward. These numbers bounce around, as you well know, but we think that that number was a little bit of a fluke.
H.L.: Around 3 million foreclosures are expected through 2012, yet Congress takes no effective action to stem the tide, and banks aren’t helping. Where are we headed in housing?
N.B.: There are a number of factors here. First of all, housing is now bouncing along the bottom, and our view is it will continue to bounce along the bottom for another six to 12 months. That’s not a very heroic forecast, but I think it’s a reality
The foreclosure issues is a big, big negative, but it’s not all negative for housing. Housing is very affordable right now, more affordable than it’s been in about 60 years, given low mortgage rates and low home prices. Home prices have not overshot on the downside. They overshot on the upside during the boom. House prices are now very, very low.
The other point to be made about housing is that the household formation number – people getting married, moving out of their parents’ homes, buying a home – typically is between 1 million and 1½ million a year, with an average of 1.2 million a year. For the last couple of years it’s averaged about 300,000 or 400,000, roughly one third of what it normally is, which means a lot of people are postponing the decision to get married and move out of their parents house, etc. That’s going to change at some point. We can debate about timing, but at some point the pent-up demand for housing is going to be relieved. And when it gets relieved, it’s going to be pretty dramatic. That’s the positive thing about housing that really hasn’t quite come into play yet.
H.L.: What do you think Congress will end up doing about the debt ceiling, the deficit, and issues with large immediate spending cuts, tax hikes and tax cuts, and raising revenue, and what will be the likely effects on the economy?
N.B.: I think they won’t put in place some spending cuts as part of the increase in the debt ceiling immediately, but at some point they’ll come to their senses, and they’ll agree, they’ll compromise, they’ll figure something out. What they will not deal with this time around, and they won’t deal with until after the 2012 presidential election, are taxes and entitlements, especially Medicare. Those are politically way too sensitive to deal with now. But they will have to deal with it. They have no choice. But they will agree on some cuts at some point. They’ll come to their senses. The alternative is unthinkable. The Republicans aren’t stupid. They’ll try to extract maximum amounts of spending cuts, but they’re not so stupid as to trigger a default.
H.L.: Will Congress will approve tax hikes and revenue raising, which Democrats want but which Republicans refuse to allow?
N.B.: I don’t think there will be much of that before the election. After the election it might happen.
H.L.: Do you think the Democrats are going to fold on that?
NB.: They don’t have much of a choice. They’re dealing from a very, very weak position.
H.L.: What do you think of the Republicans’ effort in Congress to block the regulation of derivatives – which are not regulated and which played a role in the economy’s near collapse – and their opposition to higher capital requirements for financial institutions, which would help avoid accumulation of masses of bad debts, which crippled our finances two years ago?
N.B.: The problem was not lack of regulation. There was lack of enforcement of existing regulation. Piling on more regulations, if they’re not going to be enforced, which it doesn’t look like they are right now, is meaningless. My feeling is more regulation is not the answer. Let’s enforce existing ones, and there are some pretty good existing regulations in place. They should have prevented the crisis, but they didn’t, because they weren’t enforced by most of the regulatory bodies. Most of them were asleep at the switch. Either that or they were looking the other way because they were in the hip pockets of the financials.
As for raising capital requirements, there’s probably no harm in that. Clearly the banks don’t’ want to do it, because it cuts into their profitability, but it would create a bigger buffer for a lot of these banks, so I don’t oppose that. It’s probably a good idea.
H.L.: What about regulating derivatives?
N.B.: Derivatives may have amplified the downturn and the problems, but when anybody talks about derivatives and hedge funds and the shadow banking system, that’s not where the problems was. The problem was with the commercial banks. Those were the people who were in the biggest trouble. It’s easy to blame derivatives. They’re not blameless, but go back to every financial crisis in history, and it’s always the big commercial banks that are at the heart of it.
H.L.: Is there something imperative that Congress must do to help the economy and encourage job growth?
N.B.: Stay out of the way. Every time Congress gets its fingers in the economy, it does some kind of damage. So, just get out of the way.
H.L.: Will Middle East turmoil and the major debt problems of Greece, Ireland, and Portugal set the stage for a global correction affecting us?
N.B.: They’re two different things. Certainly a major disruption in oil in the Middle East turmoil could, if they push oil prices up for any period of time over, say, $130, $140 a barrel. That’s the bigger potential risk.
Greece, Portugal, Ireland: A lot depends on if they can contain the crisis. If they can, then probably it won’t hurt the global economy, but our exposure in the U.S. to that crisis is relatively limited.