Alan Skrainka: Economy to Grow 3-3.5% as Stocks Keep Gaining

by: Harlan Levy

Chartered Financial Analyst Alan Skrainka is a principal and chief market strategist of the St. Louis-based Edward Jones brokerage. He has been quoted in The Wall Street Journal, Investor’s Business Daily, and Barron’s and has appeared on CNBC, Bloomberg TV, and the PBS Nightly Business Report.

Harlan Levy is a business reporter and columnist at the Connecticut daily newspaper the Journal Inquirer.

H.L.: This first week of earnings season may indicate how all first-quarter earnings and revenues will come in. What’s your prediction?

A.S.: I think a continuation of what we’ve seen. Expectations have been very low, and numbers on the economy have exceeded expectations, and earnings have exceeded expectations throughout this rally. We think that’s going to continue. Because of cost–cutting, corporate America is lean and mean.

H.L.: Prospects for European countries bailing out Greece seemed dire for global economies last week, then seemed to improve with the agreement on a giant loan. What do you see happening, and should we be worried?

A.S.: It’s not something that concerns us, and I don’t know if I agree that prospects for a bailout are poor. There are some hardball negotiations taking place, which is important to maintain the discipline of the Eurozone agreement. I think Greece will ultimately swallow its medicine and will demonstrate more fiscal discipline. There’s enough at stake here that Greece knows it will have to get its fiscal house in order. In the meantime if they need to access more credit, Germany and most likely the International Monetary Fund stand ready to provide it.

H.L.: What are the lessons the U.S. can learn from Greece, with its ultra high interest rates that seem doomed to plummet into a deflationary spiral?

A.S.: The U.S. isn’t Greece. The U.S. has more resources and more time. We do believe that the U.S. fiscal situation is on an unsustainable path, but we also believe there’s time for policy-makers to address it. If they choose not to address it, like Greece, the markets will address it for them.

Federal Reserve Chairman Ben Bernanke said, and we would agree, that the markets would respond very positively if we address the long-term outlook for the budget.

H.L.: By doing what?

A.S.: The solution to the budget problem is pretty straightforward. We need to do a better job managing our spending. If we choose to spend we have to raise the revenue to pay for it. We’ve got to stop making promises on the spending side., implying that it’s free.

Clearly, entitlement spending is the biggest item in the budget, and ultimately the growth rate in entitlement spending will have to be addressed.

H.L.: Should we be concerned about the growing U.S. deficit and go along with inflation hawks and higher interest rates, risking mass unemployment?

A.S.: We don’t want to put through dramatic tax increases or spending decreases immediately, because that could threaten economic recovery. But rather than forecasting all the awful things that might happen because of the deficit, we suggest the investors take steps to manage the risks that the deficit might pose.

For example, we’ll have higher inflation because of the deficit. The solution is to own equities that offer potential for rising dividends. If taxes are going up, you should own municipal bonds and fully fund your retirement plans. If the dollar falls, you should own international equities. If interest rates rise, you should stagger your bond maturities. Diversify your portfolio. The biggest risk is not the deficit. The biggest risk is assuming the government has enough money to support your lifestyle in retirement.

H.L.: Is the U.S. economy in a strong growth mode or not?

A.S.: The recovery is underway. We do think it’s sustainable. We do think the economy will grow somewhat faster than the consensus expects, like 3 to 3.5 percent, as opposed to a little less than that. We understand there are challenges like tight lending standards, commercial real estate, high unemployment, but traditionally, recessions this severe are followed by growth of 6 to 7 percent, so we’ve taken that into account.

That should be enough to support continued gains in stocks. We don’t try to forecast the short-term direction of the market, but a realistic expectation for the S&P 500’s earnings would be $80 for this year and $90 for 2011. So, the market’s trading at fair value on this year’s earnings and is a little undervalued on next year’s earnings.

H.L.: Won’t the job situation curb U.S. growth for a while?

A.S.: No. I think the unemployment rate traditionally rises 2 percent or so in a recession and falls 1 percent or so per year during recoveries, and I would expect the economy will follow the historical pattern. It’s one factor why we’re not expecting 6 to 7 percent growth.

H.L.: What’s your take on housing?

A.S.: Housing is beginning to recover. It will be a modest recovery, but I think that’s factored in our Gross Domestic Product estimate of 3 to 3.5 percent growth this year.

Disclosure: No positions