How Do Pros See the Economy?

This week, Barron's had their semi-annual "what are the pros doing/thinking" column. Below are excerpts of how different people see the economy right now.

In January I said the market probably would peak in the spring, and I recommended selling any remaining positions once the Standard & Poor's 500 crossed above the 1200 level. So far, so good. The big question now is whether the rally off the 2009 low is over or whether this is an interim correction, after which the business expansion and cyclical bull market will continue. Most investment professionals believe this is a temporary correction, declines are buying opportunities and the bull market will continue. I doubt that.

The world is at a major crossroads. Some countries are at the end of a dead-end street. Greece has hit the wall. Spain and Hungary probably will be next. The Greek debt crisis was the beginning of markets refusing to finance irresponsible public-sector indebtedness. It will travel from the periphery to the center in coming years. The common denominator in the housing crisis, the euro crisis and the banking crisis is that industrialized economies carry too much debt. These crises show that we have to rewrite our system. We have been living a fiction for the past 20 years in order to enjoy a greater standard of living. Hard times are ahead, and the steps that Europe has announced to contain its crisis are only the beginning. Governments must cut spending and promises, such as entitlement programs, and raise taxes. At best this means stagnation for some years, but it could be much worse. Deflationary pressures will increase.

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We have been talking about the "new normal." It doesn't mean a double dip in the economy or an immediate funk, but slower growth generally. We have seen some relatively strong growth in this year's first half, but the second half will be weaker in the U.S. That's the new normal, unfolding in the next 12 to 24 months.

The foundations for this view are the delevering taking place in the private market, and now in the government sector; re-regulation, which slows private enterprise and forces a more conservative investment tint; and de-globalization, which, simply put, is "every country for itself." As I discussed in January, most of our benefits and many of our problems emanate from the rather sudden trend toward globalization that began in the late 1980s with the fall of the Iron Curtain, the rise of China and the incorporation of two billion potential new workers into the global workforce. The G-10 countries have been trying to fight the forces that stole production from them. They have fought them with debt creation and leverage.

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We have had a somewhat non-consensus view that the economy would start the year on a strong note and then decelerate. Recent statistics suggest there has been some deceleration. We expect gross domestic product, or GDP, adjusted for inflation, to be about 3% this year and 2.5% next. Such deceleration isn't unusual. GDP and industrial production perked up a year ago, as inventories had been cut to the bone and companies needed to rebuild them. We also saw a nice pickup in capital expenditures, particularly for technology. Plus, we had the benefit of government stimulus, which could be seen in the housing and auto sectors. Inventories are now back to more normal levels, and the impact of the stimulus is abating. We are looking for signs that the economic recovery is broadening out. The consumer is behaving a little more vigorously, and we look for a broader recovery in real estate.

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We are focused mostly on the U.S. market. It will do better than most people think. The problems in Europe's smaller countries aren't really going to affect business in the United States. Business is good here, and will get better. Company earnings and productivity are improving. There are a lot of cheap stocks. I'm not a market prognosticator; I'm a stockpicker. But I have found, over 40 years in the business, that when there are a lot of cheap stocks, the market tends to go up. If China implodes or the European contagion spreads, we'll have problems, but I'm not predicting that. The market indexes might end the year where they started, but it is going to be a stockpicker's market.

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The stock market's 80% rally from March 2009 until April 2010 anticipated a lot of good news in the economy. But there isn't a lot of good news. Right now there is a lot of bad news from Europe. China is starting to wobble. Its stock market is down 22% year to date. We are even picking up signs of a slowdown in Chinese spending on cellphones and similar things. Europe's troubles are going to blow back here. It is a big market for U.S. technology, and the U.S. generally. With the dollar up almost 20% against the euro, U.S. companies are going to have a currency-translation problem. The currency is now a headwind.

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The April high wasn't confirmed by all the technical indicators, so I turned bearish. We have had a meaningful correction. Now the market is oversold and might rally some. But the correction hasn't run its course. There will be strong resistance at 1170 on the S&P 500, and again at around 1200. The bull market that began in March 2009, when the S&P was at 666, won't resume. The stock market could bottom in October-November, and then the rally will resume, but it might resume from a substantially lower level.

The S&P might drop to around 950. I am bearish about the world. In the second half of the year, data on economic growth and corporate profits will disappoint. At the same time the Federal Reserve is run by a money printer, and a prospective vice chairman, Janet Yellen, who said she would implement negative interest rates if she could. Interest rates, in real terms, will stay at zero forever. Investors will be badly served, in this money-printing environment, by being in cash and U.S. government bonds. The only avenue of growth is assets—that is, equities, real estate or commodities, in particular precious metals.

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We are getting a lot of mixed signals. When we talk to the companies in which we are invested, they say their businesses are seeing stable to rising demand. Inventories are still very lean. They want to do some maintenance shutdowns and they are running hard to have the inventory to be able to do that. The market, on the other hand, is manic. It is a good indicator of value over the long run but not the short run. Stocks ran up to a level at which very little was cheap. Then it came down more than 10%, and a bunch of stocks came down even more. We found some interesting things to buy. We're looking at some stocks in the oil-drilling area. We recently bought some Diamond Offshore [DO] at about 57 a share. But we don't have the conviction to load the boat yet. Most of the offshore drillers are good actors. The evidence in the Gulf of Mexico points to BP making mistakes.

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I remain constructive on the market, based on the earnings tables published in Barron's. Only one of the 30 Dow industrials—Walt Disney [DIS]—trades for 15 times 2011 estimated earnings. All the rest trade for less, and eight sell for under 10 times earnings, including stocks such as Hewlett-Packard, ExxonMobil [MOB], Bank of America [BAC] and Merck [MRK]. These are quality companies and dividend payers, though the banks don't pay much anymore. Pfizer sells at 6.7 times next year's estimates. If earnings come in close to consensus estimates, the market not only is cheap but maybe as cheap as it ever gets. It's not a bad time to put your toe in the water and invest, but given the way the market has been acting, do it carefully. Don't use leverage, and make sure you have enough cash on the sidelines in case stocks go even lower.

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First, the good news: Corporate profits are excellent. Looking across a wide swath of the industrial and consumer economy, the numbers are going up. Capacity utilization is 73.7%, against 69% a year ago. Real GDP is up 3%, against minus 6.4% at the low. Consumer spending, retail-store sales, factory shipments—all are showing positive growth year over year. The stock market isn't reacting to this; it is acting on fear. People are worried about the European contagion, but Asia is doing well. They are worried about slowing growth in China, but we should all have the problem of slowing from 12.9% to 8.5%.

What is the bad news?

In the short term, we have a jobless recovery, and if you don't have employees, you don't have consumers. Only government payrolls are up substantially year over year. The unemployment rate is unacceptable at 9.7%, or 16.6%, counting full unemployment. The public policies of the Obama administration are very disappointing. The president should have launched a jobs program, as Franklin Roosevelt did in 1933 when he inherited a mess from Herbert Hoover. Health care is important, but more government mandates will discourage capital formation and hiring.

The budget deficit is $1.17 trillion, and gross public debt is $13.06 trillion. We're not Greece. We have the right to print money. But we're not going to get away with this forever. The U.S. is spending its way into oblivion. Lastly, there is a lack of credit for small business. In the past 20 years more than 75% of new jobs have been created by small and medium-sized businesses. But only 40% of small companies were able to borrow what they needed in fiscal 2009. I expect the Democrats to take a huge hit in the fall congressional elections because they haven't focused on jobs.

In the short term, the economy will probably grow by 3%, 3.5%. In the old days we would have had a V-shaped bounce off the bottom and grown by 5% or 6%, but as Bill Gross says, it's a new era.

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My market view for the rest of the year hasn't changed. In January I thought the U.S. market would end the year up 5%, with a pretty good first half followed by a significant pullback. I thought corporate profits would be terrific, and they are even better than I thought. Companies are watching expenses, and demand has picked up. Every industrial company we talk to continues to do well. The big questions are, how do you create jobs and a more favorable environment for small business. For one thing, we need tort reform, which is unlikely to happen. We also have to divert job creation to the private sector from the public sector.

I was worried about three things at the start of the year: One was Beijing, or China cooling off; I like what the government is doing to end the housing bubble. The second was Bernanke: Does he start reducing monetary stimulation? The third was Barack, as in Obama, and how he handles the fiscal-policy initiative in light of the coming November elections. I'm adding a fourth, Berlin, which refers to the current problems in the European Union. There are also some sidebar issues.