BusinessWeek compiled comments from Wall Street economists and analysts on key economic and financial market topics on Nov. 2:
Edward McKelvey, Goldman Sachs (GS)
The 3.5% annualized growth rate reported provisionally last week for third-quarter real GDP was a stronger-than-expected exit from recession. It featured rebounds in consumer spending and residential investment, while business fixed investment and state and local spending fell less than we had anticipated. Although precise estimates are not possible, our analysis of the distribution of this growth suggests a heavy contribution from federal fiscal stimulus. In addition to the widely reported impact of the cash-for-clunkers program, we see more general evidence of a fiscal effect from income support to households and aid to states and localities. Unfortunately from this perspective, the last quarter also marked the peak of the impact of fiscal stimulus on growth, at least as we evaluate current law.
To those who are surprised by this statement, we note that: (1) the bulk of last February's package was in tax cuts, income support, and state and local aid, which took effect quickly, rather than in slow-starting investment projects; (2) the effect of stimulus on growth depends on the changes in spending it induces rather than on the level of spending itself. As the impact of stimulus fades, the onus will be on job creation to sustain growth. In the absence of that, policymakers will almost surely extend some of these programs. In fact, the first of these efforts is already under way as several expire before yearend.
We do not expect major changes in the FOMC statement [on Nov. 4]. In particular, while officials are reportedly thinking about how they might eventually modify the language regarding future interest rates, a change at this meeting is quite unlikely.
Ethan Harris, Bank of America Merrill Lynch
With the economy turning up, the markets are on high alert for rate hikes from the Fed. Every time an FOMC hawk says that "the Fed will need to raise rates sooner rather than later" or Fed staff talks to the Street about technical issues around its exit strategy, the chattering class gets excited. The latest "Fed fake" is a newswire story about Michael Woodford, a member of the Monetary Policy Advisory Panel for the Federal Reserve Bank of New York. Asked if the Fed will soon drop its promise to keep rates low for an "extended period," he responded: "I could imagine them dropping the language." He went on to explain that "the problem with this kind of language is that it's perceived as making a promise about future interest rates independently of what happens in the meantime." Is this close adviser to the Fed signaling a change in the Fed directive this week?
The answer in our view is almost certainly "no." It is important to understand how the Bernanke Fed signals major policy changes. The signals don't come from Reserve Bank presidents or advisers; they come from either the overall committee—in the form of the official statements—or from the core of the committee—that means Bernanke, [Fed Vice-Chairman Donald] Kohn, and to a lesser extent New York Fed President [William] Dudley. The Advisory Panel plays a very secondary role in thinking at the Fed. When I was at the Federal Reserve Bank of New York, we had to brief the advisory group before they talked so they were up to speed on the data. Moreover, the directive already includes the contingent language Woodford recommends. It says: "economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period." Perhaps the Fed could expand this and say: with considerable economic slack and a likely moderate recovery, economic conditions are likely to warrant…
Michael Englund, Action Economics
Upside surprises in U.S. reports [released Nov. 2] for the Institute for Supply Management's October manufacturing index and its employment component, alongside the 6.4% pending home sales surge [in September] and robust residential construction figures [for September], have prompted upward revisions in our fourth-quarter and first-quarter GDP estimates to 2.3% for both quarters. Residential construction now looks poised for 20%-25% growth in both quarters, following a comparable gain in the third quarter that should be revised to 22% from 23.3%. And the strong ISM data have capped the downside risk in the October jobs report, as well as the early factory sentiment figures for November.
Yet, all was not rosy in [the Nov. 2] reports, as surprisingly weak nonresidential construction figures suggest an ongoing downward spiral in this important investment component. And big downward construction revisions imply that third-quarter GDP growth will be knocked down to 3.3% from 3.5%.
Tony Crescenzi, Pimco
Fed data released [on Oct. 30] indicate banks increased their cash holdings by a record $160.6 billion to a record $1.344 trillion in the week ended Oct. 21, reflecting a renewed expansion of the Fed's balance sheet. Bank loans continue to move in the opposite direction as bank cash, with loans and leases at the nation's commercial banks falling for a 21st consecutive week, by $32.9 billion to $6.684 trillion. Thus far this year, the total amount of loans and leases outstanding has contracted $530 billion, a 9.1% annualized rate of decline. Commercial & industrial loans, which are a subset of the loans and leases figure, have fallen at an even faster pace of 17.3% year-to-date. The contraction in lending stands in sharp contrast to the trend in commercial bank holdings of securities, which have increased $210 billion thus far this year, or a 12.5% annualized rate of increase.
Weakness in bank lending is not unusual in the early stages of an economic recovery, because companies in the early stages can rely upon internally generated funds to finance their expansion. In fact, in six of the 10 recessions since 1948 a trough in bank lending did not occur until six months after the recessions ended. In two of the cases (1948-1949 and 1980), a revival occurred the same month as recession's end. Still, broken business models, overleveraged borrowers, capital-starved banks, and forthcoming increases in capital requirements and other regulations mean that the recovery in bank lending could take longer and be more restrained than usual.
Sam Stovall, Standard & Poor's
On Oct. 19, a few days after the Dow Jones industrial average closed above 10,000, the Standard & Poor's 500-stock index ended near the 1098 level, after peeking its head above the 1100 threshold on an intraday basis and registering almost a 4% month-to-date advance. Since then, however, it's been all downhill. However, S&P's Investment Policy Committee thinks the S&P 500 will close the year around 1055, based on its 12-month target of 1150. We believe the market is undergoing a digestion of the 25% advance experienced since the July 10 decline that shaved 7% off the market following the 40% surge since the bear-market bottom.
We believe the decline we are currently experiencing could be of a similar magnitude. Mark Arbeter, S&P's chief technical strategist, sees 1025 as the next level of support, which would equate to a 6.7% decline from the recent recovery high. In addition, our economic and fundamental core beliefs remain intact. Combined with our expectations for a pullback in share prices over the near term, rather than a deeper correction or even the end of this embryonic bull market, S&P's Equity Strategy group continues to lean toward the cyclical side of the sector ledger, with overweight recommendations on the Energy, Industrials, and Materials sectors, while underweighting Telecom Services and Utilities.