Around the Street

Experts Weigh Stocks, the Dollar, and the 'Fiscal Hangover'


By BusinessWeek Staff

BusinessWeek compiled comments from Wall Street economists and strategists on the economy and markets on Aug. 24:

Kim Rupert, Action Economics The markets have traded in recent weeks as if they were from different planets. Most global equity markets have been buoyed by recovery enthusiasm. Meanwhile, bonds have been boosted by concerns the recovery will be stilted. The typical inverse relationship between stocks and bonds became detached at times last week. This war of worlds won't be won or lost this week, but after mostly upbeat comments from central bankers at last week's Kansas City Fed-sponsored Jackson Hole symposium, the onus will be on data to prove stocks are overvalued.

Tobias Levkovich, Citigroup (C) Several investment opportunities have emerged following the more than 50% gain in the S&P 500-stock index since the March intraday lows as various groups still look appealing, as they are trading well below their historical average relative performance relationships…[the] capital goods industry group is trading at roughly two standard deviations below its historical mean, last seen around early 1999 before it substantially outperformed the market in the subsequent two years.

The diversified financials, banks, and insurance groups are all trading well below their mean relative performance levels, suggesting opportunity remains in place even after the impressive rally experienced over the past five months. Our valuation and earnings revision analysis similarly argues powerfully for the insurance industry group, but the banks group may be more stretched. Retailing stocks have bounced sharply, and while they seem to have some further relative upside potential based on prior highs, they now trade at levels that suggest some caution may be appropriate.

Aside from the political backdrop of health-care reform, the pharma and biotech group is trading in relative terms roughly a standard deviation above its historical mean. Moreover, our valuation analysis is not indicative of outperformance either.

Marc Chandler, Brown Brothers Harriman European Central Bank President Trichet, speaking on [Aug. 22], warned that while the euro zone economy may no longer be in free-fall, these signs do not mean "at all that we do not have a very bumpy road ahead of us." The comments suggest the ECB will continue to maintain emergency measures to help support the financial system and the economy for an extended period. Indeed, while other central banks, including the Fed, have begun to discuss the prospects for an exit strategy, albeit at some distant point, the ECB does not appear to be joining in, a factor that could come back to haunt euro bulls over the longer term as the U.S. economy begins to gain strength.

Alec Phillips, Goldman Sachs (GS) After several years of low taxes and an enormous fiscal package enacted early this year, policymakers will soon be confronted with a new set of challenges. The growth effect of the stimulus enacted early this year will begin to fade by early 2010 and will constitute a significant drag by 2011. The expiration of the tax cuts enacted in 2001 and 2003 will add to the drag in 2011 and again in 2012 if they are not extended. The financing of the pending health reform proposal could add to the drag. Assuming an otherwise neutral fiscal stance, this would reduce spending and/or raise taxes by 2.5% of gross domestic product in 2011 and 1.3% in 2012. In other words, the economy faces quite a fiscal hangover.

The question confronting lawmakers now is whether to wean the economy off its large dose of fiscal stimulus with another smaller dose, or force it to go "cold turkey" in light of large deficits by letting the stimulus run off and tax rates expire.

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