IHS Chief Economist Nariman Behravesh: Stocks Up 5-6% In '14, Fed Rate Rise In Q2 '15

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


The Federal Reserve won't raise rates until the second quarter of 2015.

Stocks up by single digits in 2014 - 5-6 percent.

150,000 - 200,000 new jobs per month in 2014.

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 do you think of the Federal Reserve's cutting another $10 billion from its monthly purchases to $55 billion and new Federal Reserve head Janet Yellen's comments that it will stop entirely in the fall and raise interest rates probably in six months?

Nariman Behravesh: The decision by the Fed to continue the tapering process comes as no surprise. They've been saying this for some time, and we fully expect them to continue down this path and by the end of this year to stop any further purchases of government bonds and mortgage-backed securities. So no surprise there.

In terms of Janet Yellen's statement last week that the Fed might start raising rates in about six months, that caught us and everybody by surprise. Our expectation is that the Fed probably won't start raising rates until the second quarter of next year.

In that sense we were surprised. I don't know what to make of it, to be perfectly honest. I think it just slipped out, and it wasn't her intention, and I don't sense any consensus that the Fed is ready to raise rates in six months.

They're still somewhat concerned about growth and the amount of slack there is in the labor markets. In particular, they don't believe that the unemployment rate of 6.5 percent is the true condition of the labor market. They think there's more slack and more pain in the labor market than a 6.7 percent unemployment rate suggests.

So, based on that, our view is that what they're doing is gradually taking their foot off the accelerator, and they're not going to step on the brakes - raise interest rates - until the economy is on a better footing.

What they are doing is good. They are preparing for the fact that they need to stop these very extraordinary measures they've been taking for the economy. They feel the economy is improving, but it's not quite there yet, so their policy is consistent with that view.

Q: How do you describe U.S. fiscal policy, and how effective or ineffective is it?

A: On the one hand U.S. fiscal policy has been successful in stabilizing our debt ratio, so the debt ratio to Gross Domestic Product has stopped rising and has leveled off. By that measure it was successful.

They did that through big spending cuts, the sequester, and big tax hikes at the beginning of last year. The problem is that the political process that brought this about was terrible and embarrassing. Secondly, it hurt growth, so the fiscal austerity that we had last year cut growth by 1.5 percentage points.

Now they don't need to do as much this year or next year in the way of fiscal tightening, so the drag from fiscal austerity will be much less this year so the underlying strength of the economy can manifest itself.

Q: If the fiscal policy continues to maintain spending cuts and lacks spending on infrastructure and other measures that would add jobs, what will happen?

A: My hope is that if the Republicans take control of the Senate and keep control of the House they will tackle the elephant in the room - the two entitlement programs and tax expenditures, a tax code that looks like Swiss cheese with lots of loopholes. They would do the country a great service if they would tackle those two issues.

Q: What do the latest housing data tell you about the housing market now and in the future?

A: Certainly housing has had a very good run with strong growth in terms of sales and starts. But it is clearly slowing down. What we don't know is whether it's weather-related or whether after a period of strong growth you'd expect to see a pullback.

Q: Is the job situation improving much?

A: The job picture is improving gradually but clearly was dealt a setback in December and January. Some of that was bad weather, and some of it was just a slump in the economy.

Going ahead, we fully expect job growth in the monthly payroll numbers of between 150,000 to 200,000 a month. It's decent. It's not great. At that point it's a B to B-minus. It'll just keep things going, not as fast as we like it, but it will keep things going.

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

A: Manufacturing has done extremely well recently, although there was a bit of a pause earlier this year. Some of it may be weather-related. But I expect manufacturing to continue doing quite well in the U.S. There's a variety of things helping U.S. companies. One is a competitive dollar, so exports are benefiting. The other is that our energy costs are very low right now so that's helping some of the more energy-intensive industries.

HL: Do you see stocks continuing upward?

A: Last year was a banner year for the stock market, with the S&P 500 up 30 percent. We cannot expect anything remotely close to that this year. I would expect single-digit growth of 5 to 6 percent and a fair amount of volatility.

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

A: This year up 2.5 percent. Next year, a little over 3 percent, 3.1, something like that.

Q: What has surprised you the most this year?

A: We keep getting geopolitical surprises. And certainly the situation between Russia and Ukraine was nothing anyone would have thought about. It might affect Europe but probably won't have a big impact here in the U.S.

Q: What's the biggest threat to stability these days?

A: In terms of the U.S. economy, the biggest threats are external. Some geopolitical event in Europe or Russia or the Middle East or Asia that would hurt global growth I think would certainly hurt U.S. growth. That's what keeps me up at night.

One of the fears we have is that China's growth, which has come down quite a bit in the last few years, could be much weaker in the coming year. Everybody expects 7.5 percent growth this year, and it's certainly possible that it could be quite a bit lower than that. It wouldn't hurt us that much, because we don't export that much to China, but it would hurt some Asian economies and the emerging market commodity exporting markets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.