Interview with Nicholas Perna: 'Hard to See a Significant Rise in Stocks'

Includes: DIA, QQQ, SPY
by: Harlan Levy

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

H.L.: What did you take away from the Federal Reserve conference you attended on Friday regarding the state of the economy and the Fed’s ability to spur recovery through quantitative easing?

N.P.: Fed Chairman Ben Bernanke is concerned about two things: one is the slow pace of the recovery. The other is surprisingly low inflation. This is extraordinary. The Fed has never said inflation is too low in my memory. But they’ve been saying it now for about a month, and he underscored that Friday. And he said there’s a concern that we could slip into the morass that Japan has been in for the last 20 years, their lost two decades.

With short-term interest rates at effectively zero, there’s nothing left to do but quantitative easing, which is really large-scale purchases of Treasury bonds and mortgage-backed securities. The purpose is to try to bring down long-term rates, which would stimulate the economy. As for whether this would create inflation, Bernanke hopes it will raise inflation expectations -- but he didn’t say that explicitly -- in order to defeat the forces of deflation.

H.L.: But how effective do you think that will be?

N.P.: We’ve already seen the effect. The bond market already lowered long-term interest rates in anticipation of imminent quantitative easing. Hopefully it will lower the cost of capital for business investment.

But the real question is whether it will accelerate economic growth or simply keep us from slipping further. I think it’s in between. The odds are it will keep us from falling back into recession, but we will still have the problem of not creating enough jobs to keep the unemployment rate down to acceptable levels.

H.L.: How bad is the continuing drain of job losses and paltry private job gains?

N.P.: We’ve been having job gains throughout much of 2010, but they haven’t been large enough to make a serious dent in the unemployment rate or to generate significant household income increases. We need close to 2 1/2 percent Gross Domestic Product growth Bernanke said on Friday was that we wouldn’t be getting enough GDP growth to get the unemployment rate during the coming year.

The downside risks are greatest in the coming year. If we get through mid-2011 and the Bush tax cuts are extended, if quantitative easing lowers long-term rates, if we get some help from exports, and if the political environment doesn’t degenerate the downside risks will diminish.

H.L.: What are the chances those things will actually happen?

N.P.: I give it a 50 percent chance. The probability that the economy will keep growing over the next year is about even money, and the odds of a relapse into recession are somewhere between 25 and 30 percent. Those are uncomfortable odds.

H.L.: But isn’t the economy’s real problem lack of consumer demand?

N.P.: Consumer demand is growing slowly. Housing is much more of a problem. And so is purchasing by state and local governments. They’re cutting payrolls and people, and it might be better if we got another stimulus package or a tax cut, but that doesn’t seem likely. My own preference would be a payroll tax holiday, where employees and employers don’t pay Social Security and unemployment taxes for a year. That would put money right into the hands of businesses and consumers. But Congress is too busy running for reelection.

H.L.: How much has the foreclosure crisis and the resulting massive halt in foreclosures jeopardized the economy?

N.P.: First of all we don’t know the full magnitude of the problem, but the uncertainly couldn’t come at a worse time. Hopefully it will clear up soon. Otherwise it could cast a real pall over home purchases, further slowing the recovery.

H.L.: Third quarter earnings are now coming out. What do you expect, and what will the earnings reveal about the true health of corporations?

N.P.: There is an improvement in financial business earnings because the banks are able to take smaller write-downs of bad loans. However, there is uncertainty from the foreclosure moratorium. That will affect future earnings, not third quarter earnings. Overall at some point, you start to get earnings for businesses in general that reflect the slower growth of the economy and not the big gains that we were getting in the early stages of the economy.

H.L.: The stock market has been on a wild upward ride. Will it continue, or is the emperor wearing no clothes?

N.P.: The emperor is partially dressed. Where the stock market goes from here is really a matter of where the economy goes from here. The stock market faces the uncertainty of future economic growth, and it’s quite sensitive to future interest rates. I don’t think long-term rates will go down much more, so I find it hard to see any overall significant rise in stocks.

But one positive for certain types of stocks is that I expect the dollar exchange rate to continue to weaken in the coming year, which is good especially for exporters and companies with overseas operations when they bring their earnings back to the U.S. That’s one of the effects of quantitative easing.

H.L.: If the Republicans regain control of the House of Representatives and maybe the Senate, what would their plan of radical budget cutting – except for Social Security, Medicare, and defense – do to the economy?

N.P.: You’ve exempted most things, and it’s very difficult to eliminate the budget deficit by exempting that much of the budget. If you can’t cut interest payments as well as those programs, there isn’t a heck of a lot left that can be cut. There needs to be more detail on their plans.

As a general rule, it would be very difficult to eliminate budget deficits without raising taxes, no matter who’s in office. I mean, let’s get real.

But I have a proposal to save the republic: Amend the First Amendment so we can ban political advertising. It serves no useful purpose. It’s all distorted. What happens is that it costs billions of dollars to put that nonsense on television, and the bill has to be paid. That is, whoever wins is obligated to do the bidding of whoever paid for the ads.

Disclosure: No positions

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